Last month, Fannie Mae and Freddie Mac all but ended Interest Only Mortgage loans, so the only loans left are Amortizing Mortgages.  (Some borrowers can still get an Interest-Only style mortgage, but they are very restricted now).

If you have ever closed on a mortgage, you probably remember the large stack of paperwork you needed to sign.  A large chunk of that is the “Amortization Schedule”, which is the spreadsheet that shows month by month what the loan balance is projected to be, how much of your payment goes to interest, principal and mortgage insurance if possible.

An Amortizing Loan is simply a loan where your payment never changes, but the amount you pay in interest declines each month as the principle balance is paid down. (Here in North Carolina, the banking commission makes us use two pages of disclosures in the loan application package to explain that one sentence).

The Amortization Schedule is a useful tool for an Annual Review of your mortgage.  However, there is a major problem with the original Amortization Schedule you received at closing.  As soon as you pay as little as $1 extra in principle, the remaining months on the schedule become inaccurate.

When you pay extra principle on your mortgage, you shorten the term of your loan, effectively skipping past months on the schedule.

Here are a few ways to shorten the term of your loan, if that is something you want to do:

1. Bi-Weekly mortgage payments.  This is a separate service from your mortgage servicer that deducts half of a regular mortgage payment from your checking account every other Friday.  There are 52 Fridays each year, so this means you make 26 half payments or 13 full payments each year.  The extra payment each year shortens your loan term.  The problem with Bi-weekly mortgages is that you usually have to pay a fee of up to $400 for the privilege or sending the bank your extra payments.  It seems that they should pay you for sending in extra payments, but they don’t.  Bi-Weekly payments are handy if you get paid every other week so that you can have half your mortgage taken from each paycheck.
2. The ‘Banker’s Secret’.  A book from a few years ago explained the so-called Banker’s Secret.  What this program did was to have you pay the regular payment on the mortgage on the due date, but add in the extra principle from the next month on the Amortization Schedule.  This skips you down the schedule every month and effectively cuts your loan term in half.  The gotcha here is that as you get later on in the amortization schedule, you have larger and larger principle payments to make extra each month.  If you aren’t earning more money each year and don’t desire to put that money into home equity, the Banker’s Secret is actually a secret way for them to get more money from you faster, so that they can lend it out again and earn more interest.
3. Make One Extra Payment each year.  If you get an annual bonus or a regular tax refund, making one extra payment each year allows you to get the same benefit of the bi-weekly repayment plan without having to pay the extra fee.  This extra payment will go all towards principle, and not interest, so it will jump you pretty far down the Amortization Schedule each time you do it.  Maintain this practice for the term of the loan and you’ll reduce a 30 year loan to just over 24 years.

You can contact me for a free update of your Amortization Schedule – even if I didn’t originate your mortgage – I have some pretty good software to create an accurate update.

If you are a “Do it Yourself-er”, download a useful excel spreadsheet and plug in your own numbers.

Paying extra payments on the mortgage feels good for a lot of people.  Don’t fall into that trap of basing your financial decisions on your feelings!  If there are better uses of your money, such paying off other debts, building an emergency fund, or saving for kid’s college expenses – do that first.  Those beneficial decisions not only feel good, but are good for you.

You often have to choose how to balance your savings between “liquid” cash, paying off bills, saving for retirement or college and paying down the mortgage. If the Great Recession has demonstrated anything, it’s that home equity is a poor choice. You can find out a lot more about this in previous blog posts.  I’ve written at some length on this on my blog.

Here’s a sobering statistic from last months ‘good’ jobs report:  44% of unemployed persons were out of work for 27 weeks or more. When someone loses their job, they’ll never say, “I’m so glad I have a 15 year mortgage and have paid $50,000 extra towards principle”. No, at this point, the higher mortgage payment and the equity suddenly trapped in their house is frozen from them.

With a mortgage payment and the need to eat and pay utilities, could you go half a year without a pay check? In today’s ‘new normal’ economy, you need to work towards the day where you can confidently answer ‘yes’ to that question.

If you can’t, often times the mortgage currently in place is a good place to start – either by getting a lower payment to grow savings faster and reduce expenses, or maybe by taking cash from the house and putting it where it can grow, be safe, and be available.

If you haven’t looked at your house equity in light of how much cash do you have available, maybe that is a good place to start.

Your first economic priority needs to be liquid cash.

There are two reasons to have  a ready stash: something good happens or something bad happens.

Good things that require cash:

• Your child is accepted to a terrific (but more expensive than planned) school
• You have an opportunity to invest in a vehicle that will enable you to reach the Financial Freedom Point faster than you planned on.
  
• You get to start your own business
• You get offered a ‘once in a lifetime oportunity’ and need to pay for it

Bad things that require cash:

• Job loss or falling income
• Medical procedures
• An elderly parent in failing health
• Home repairs

A recent Urban Institute study on workers aged 45-79 is troubling:

• Average wages for retirees from long-term jobs (with more than 10 years of service) who continued to work declined by about 39 percent
• Median wages plunged by 53 percent
• Older people displaced from long-term jobs who found other employment experienced average wage losses of about 19 percent

This study shows that we can no longer assume wages and income will always increase or always be there.  Having some cash available can make the difference when life happens – will a setback be a bump in the road or a cliff?

Too many people have too little cash in the bank – blindly hoping that nothing bad ever happens, or if t does, the credit cards, home equity lines, or government stimulus programs will bail them out.

Set a goal for yourself and your family to build to at least $10,000 in liquid savings and then grow it from there. If you are at a big company that has to lay people off to make their quarterly numbers, or if you are in an industry that is struggling right now, you will want even more cash available to you.

In my “Start with the House” philosophy, I place liquid cash at a higher priority than buying a house, paying off credit cards, or saving for retirement.  Having sound priorities for your money will make it more likely that you will succeed financially. 

A lot of people dream about the day when they make their last mortgage payment and they finally own their house “Free and Clear”.  Sounds nice, doesn’t it? Unfortunatley, there are two problems with this dream – that can turn into a nightmare if not planned for.

Even with no mortgage, you can still lose your house.

Try not paying the property tax bill for a few years and see how good it was to pay off the mortgage.  Or, consider what happened to the thousands of homeowners who lost houses when hurricanes pass through town at 100+ miles per hour.  Last time I checked, Hurricanes don’t care if you have a mortgage or not.

Paying off your house each month with extra principal payments is the riskiest way to pay off your house.

Consider your friends or family members in places like Florida, Michigan, or California. If they sent in extra principal payments to their mortgage servicer, what happened to that money as home prices declined?  I know someone with a 15 year mortgage that sent in $2,000 per month to watch their house decline in value by $3,000 every month.  When you send in extra mortgage payments, your lender transfer the risk of the mortgage right back to you.  Put another way, each time you send in extra principle payments, your lender has less risk, and more of your money is now in a place where it can disappear or be destroyed.

If you send in extra principal payments, and then find you need the money back, you may not be able to get it.  It could have disappeared, like it has in some parts of the country, or the mortgage rules or your circumstances may have changed to where you can no longer get your money back.

Another way to be Free of your Mortgage:

If you had wnough money to write one check and pay off your mortgage, isn’t that the same as not having a mortgage?  Strictly from an accounting perspective, it is.  On a balance sheet, if the cash assets were greater than the mortgage balance, you are debt free. Now it just becomes a matter of deciding if you should pay off the mortgage, or keep things the way they are.  Think about it – what if you had a $300,000 mortgage, and $300,000 in investments that were targeted as ‘mortgage payoff funds’. You could write one check whenever you wanted to and eliminate that mortgage.  Or, you might recognize some benefits of having both investments and  a mortgage.

• Grow your savings over time, and after a while, the compound interest you earn will be much greater than the interest you pay.
• Mortgage Interest is Tax Deductible – having the mortgage may allow you to pay less in income taxes and keep more for yourself.
• Your mortgage (if it’s not interest only) will pay itself off over time – just let it do that.
• You have more freedom where to store your money – rather than putting it into the walls of your house, choose where it should best be stored for safety.
• If something happens to your house, you still have your money – separate the house and the wealth to keep both safe.
• Your money can earn Compound Interest if it is working for you.  Inside your house, it is just sitting still doing nothing.

Reaching the Freedom Point

You are debt free when you have enough money to pay off your mortgage.  You could still lose your house even if you have no mortgage, so don’t kid yourself into thinking a mortgage payment is your only threat.

A better goal in today’s economy is to plan to reach your Freedom Point as soon as possible.  Just be sure to plan ot do it the fastest, safest, way possible – store your money where it can be accessed if needed and where it grows for you.  You will be able to decide if you want to pay off your mortgage much faster and safer this way.

If you haven’t developed a plan to reach your Freedom Point by a certain day, give us a call – we can help you create a home ownership plan with a path to pay off your mortgage in the fastest and safest way possible.

If you were asked to make an investment in which you were told you would never see your money again, how much would you invest?

If you put money in a savings account each month, and the bank guaranteed you that you could never withdraw the money again, would you keep depositing checks?

If your savings account was only available to keep your bank from losing money, but you could still lose money, would you keep money in that savings account to protect your banker?

If you put money in an account that was guaranteed to never pay you more than 0% interest, would you want to save your money in that account?

What if the money in the 0% account could lose money, even if it couldn’t gain money?  How much would you put there?

What are these horrible accounts I am talking about?

Did you guess Home equity?

Think about it -

• When you make a big down payment on a house, you don’t get paid money each month by the bank for that, do you?
• When you send in extra principal payments, does the banker pay you interest?
• If your home loses value, does the bank lower your mortgage balance, or does your ‘Home equity Savings Account’ disappear?
• If you have a lot of equity, does that make your house go up in value?

Down Payments, Home equity and mortgage repayment or early payments are all questions regarding where you should store your wealth over the long term.  Equity in your house doesn’t make you safer or wealthier – it just sits there.

Big down payments are safe for the banker – not you!

Of course, you pay interest on money you borrow, but that is a choice – you can pay interest, and store your money elsewhere, or not pay interest, and maybe keep the bank from losing money.

Make sure your mortgage provider asks a lot of questions about down payment amounts and home equity before you structure your mortgage.

If you already are in a mortgage, get an annual checkup to make sure your mortgage is helping you to succeed financially, rather than helping the bank succeed.

If your mortgage is set to adjust this year, the smart move may be to let it. Today’s conforming mortgages are adjusting lower than ever before — as low as 3 percent.  It may not be what you expected when you signed for your ARM several years ago.

The reason why ARMs are adjusting lower is because of how they’re made.

When conforming adjustable-rate mortgages adjust, they adjust according to a pre-determined formula. The formula is the sum of a constant and a variable.  The constant is usually 2.25 percent and the variable is a daily-changing interest rate called LIBOR.

The formula looks like this:

New Mortgage Rate = LIBOR + 2.250 percent

LIBOR is an acronym for London Interbank Offered Rate.  LIBOR is very similar to the Federal Reserve’s Federal Funds Rate.  Banks borrow and lend money from each other at the LIBOR or the Fed Funds Rate.

Normalcy is returning to banking and the timing couldn’t be better for Charlotte homeowners with ARMs. 15 months ago, a homeowner’s ARM may have adjusted to 6 1/2 percent.  Today, that same ARM falls to just above 3.

As a strategy play, it might make sense to let your ARM adjust. Or, because fixed rates are still near 5 percent, converting that ARM to a long-term fixed-rate product might make sense, too.  The decision is a balance between how low do you want your payment, and how long might you live in your home.

The longer you stay, the more it might make sense to switch to fixed-rate, even though ARM rates are so low.

If, however, you are in an Option Arm, and Interest Only ARM, or a Sub-Prime ARM, it won’t be so simple.  You want to carefully review the original mortgage paperwork to see what will happen with that loan when it adjusts. I can help with that.

If you’ve got a conforming, adjusting ARM, it makes sense to review why you chose that program 3,5, or 7 years ago – if htose reasons still amke sense, maybe you should keep it.  Of, it may be time to lock in a new rate for 5,7 or even 30 years.

WARNING: This a graphic story of the financial destruction of an otherwise financially successful man.

Here’s a secret for you – your credit score will go down every time you do something that people did previously just prior to defaulting on their debts.  The credit scoring model is trying to predict the likelihood of you going 90 days or more late on an account.  If someone ever defaults on a debt, they leave clues well in advance of that default.

Here is the pattern of clues John left as he trashed his credit following a medical incident that left him out of work for a few months:

1. John needed some cash, so he applied for new credit.
2. Having a lot of equity in his house, John applied for a home equity line, but the application was denied since he wasn’t working.
3. With the financial pressure of medical bills and no income, John could no longer pay off his cards in full each month.  The amount owed starts to increase close to the limit on the cards.
4. Needing cash, he turned to alternative sources, getting a signature loan at a high interest rate.
5. He was late on a few credit card payments as the money just wasn’t there to make the payments on time and he was juggling the many open accounts.
6. Creditors turned over John’s accounts to collection agencies, who immediately notified the credit bureaus of the collections.  Collection agencies wanted to lower his credit score to prevent him from opening new accounts, leaving him with a greater chance of paying the collection agency off.
7. (Trying to sell his house didn’t help as the market was slow and declining, so his equity was disappearing).
8. John first went to a credit counseling firm and then eventually filed for bankruptcy.
9. Some debts were wiped out in the bankruptcy, and he just quit making payments on the remaining debts, feeling the situation was hopeless.
10. Creditors file suit and judgments get reported to his credit report.
11. Being unable to manage then debt load, he is late paying his taxes and a tax lien is filed in court against him.
12. Unable to even make his mortgage payment with the high costs of his other bills, the house is lost in foreclosure and all the equity in the house disappears in the soft real estate market.

John’s credit destruction was now complete after just a few tragic months.  The impact will last for years, as most of these items will impact his score and stay on his credit report for seven to ten years.

While this story is a myth, the events and results happen to good people every day.

Following the StartwiththeHouse.com strategy would have helped:

1. Always have an emergency fund – this would have tied John over during the short period when he wasn’t working.
2. Keep credit cards and other loan payments very low
3. Have proper insurance against all the threats out there – not just uninsured motorists, but illness, sickness, death or lawsuits as well.
4. Store your cash where is can be accessed.  In the above story, John had over $200,000 of equity in his house – but with no job, he couldn’t access it and lost his house in addition to destroying his credit.

Your mortgage can’t be just a loan to be hated – today it has to be an integral part of your overall financial plan to help you succeed financially.  Could you survive two months without work with the increased expenses of a health issue?  If not, what are you doing to make sure you have a different outcome?

When you got a copy of your credit report (www.annualcreditreport.com) last week, I asked you to count your tradelines.  If you didn’t get your credit report yet, read this post first on how & why.  If you have been using credit for more than 10 years and have no late payments, you are at a place where you likely want to start using less credit.

The people I see with 800+ credit scores will have  a very good, long credit history, with never a late payment, collection account, or bad debt, and they will have very few active accounts.

• Pick 2 credit cards to keep open – usually Visa, MasterCard, or American Express, not department store or gasoline cards.  Pick the cards with the longest time open as well.

  

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Closing the other cards will not impact your score as you have a strong credit history.  If you have any blemishes on your report – skip this step!  It’s only to help someone go from really good credit score to outstanding, like  a 760 to an 800.

• Never miss a payment date.  In fact, I usually pay off both my cards in full every two weeks when I get paid to never let the balance get high.  You have to keep balances extremely low – like 10-20% of the maximum limit to have an 800 score.

• Stop new offers from coming in.  Visit www.Optoutprescreen.com to have your information blocked from credit card offers. This reduces the chances of fraud, identity theft, and new inquiries on your credit report.

Ideally, to get an 800 plus credit score you will have:

• Mortgage Loan
• 2nd Mortgage (Optional if needed)
• Auto Loan
• 2-3 Credit Cards that have been open for many year with very low balances

In my next post, I will show ways to get to a 740 FICO if you aren’t there yet.

I am offering a complimentary review of credit this month – if you want me to look over your report, email me for more information on this free, no obligation offer.

Know what you are working with!

If you haven’t seen your credit report in a while, get a copy now.  There is only one place for a truly ‘Free’ report – but it comes with a catch – www.AnnualCreditReport.com will give you a copy, but the catch is you have to pay for your score.  At this point, you don’t really need the score, but you can pay the extra money if you want to.

Other services (with catchy radio jingles) offer free reports, then try to sell you their service.  Use with caution.

When you get your report, you need to decide if you are in one of two camps:

1. I don’t have enough credit and need more credit history
2. I have very established credit history, and too much credit.

Your credit score will usually reflect the categories above – if you are below a 720-740 range, you need more or better credit history.  If you are above a 750, your score won’t improve further with more credit accounts, in fact, you probably have too many accounts to keep your score from getting even higher.

Credit scores range from 350-850

The lowest I’ve ever seen is in the 400′s, and I routinely see credit scores in the 800-810 range.  Above 820 is just luck.

What Score do you need?

• To buy a house with an FHA loan: 620 (Although the FHA says 580 officially)
• To buy a car:  700
• For a Jumbo Mortgage:  680-720
• Best rates on a Conforming mortgages: 740

Above a 740, credit scores are really just bragging rights, but the higher the score is, the more buffer you have in case something happens to your score. If you have an 810, for example, and a credit card payment gets lost in the mail, the late score won’t affect your home mortgage rate. However, if you have a 741, and then make a late payment, you will drop below 740, and then your mortgage rate would be higher.

Step One:

After getting a copy of your credit report – count the number of active “tradelines”, or active accounts that are on your report.

• More than 4 tradelines:  We’ll probably close some of them down.
• 4 or fewer tradelines: You will want to get some new credit.

Check back in a few days after you get your credit report copy and we’ll talk specific strategies for both groups.