Friday, September 19, 2008

HELOC - Here Today, Gone Tomorrow?

The news is filled with the possibility of the global economy grinding to a halt due to a lack of credit. But for many of us, this has already occurred. For years, American homeowners used their homes as credit cards, borrowing against the equity via a Home Equity Line of Credit (HELOC). These loans supported a wide variety of purchase such as medical expenses, college tuition, and vacations. But the spending spree is now over.

HELOC's are a line of credit based on the equity in your home. The lender assesses the value of your home, subtracts any existing loans, and if they feel there is sufficient equity, they offer a maximum loan amount. For example, if your home is valued at $100,000 and you have a $50,000 first mortgage, the remaining equity is $50,000. Based on this calculation, the lender may offer you a line of credit of up to $30,000. You do not borrow the money all at once. Rather, like a credit card, you use as much as you need, up to the $30,000 limit.

But as the economy weakens and housing values decline, HELOC's are becoming more rare. Many banks and savings and loans no longer offer these loans. And those who do, are requiring a larger amount of equity before they will consider allowing a HELOC.

For those of you who already have a HELOC, you may discover that your lender has frozen the loan and you can no longer access the funds. This means that even though you have not used up the full amount in your equity line, you could find that funds in the account are no longer available. Without prior notice, the bank could suspend the account if they find that the home's value has dropped so low as to not support the loan. And you could find yourself in the uncomfortable position of writing a check from your HELOC account only to have the check bounce.

If you have a HELOC and think you will need the funds in the near future, you may want to pull out the balance of your remaining credit line now, before the credit line is frozen. But do not make this decision lightly. In today's precarious financial times, HELOC's should only be used for absolute necessities. And they should never be used unless you are certain you will be able to pay the additional monthly costs.

Tuesday, September 16, 2008

Are Your Deposits Safe?

I have received a number of calls and emails from clients asking if their deposits are safe or if they should pull their money out of their banks. Most deposits are insured by the Federal Deposit Insurance Corporation (FDIC), up to $100,000. If your bank or savings association is insured, and if your accounts come under the insurance limits, your money should be safe.

To check whether your bank or savings association is insured by the FDIC, call toll-free 1-877-275-3342, use Bank Find, or look for the official FDIC sign where deposits are received.

To find out if your deposit amounts are fully insured, go to EDIE. This calulator on the FDIC site will help you determine if your deposits adhere to the insurance limits.

What To Know Before You Co-Sign A Loan

Today it is difficult, even for strong borrowers, to get a loan. To give them the extra edge needed for loan approval, some borrowers are asking friends or relatives to act as a co-signer on their debt. Before you decide whether or not to comply, make sure you know what you're getting in to.

Simply put, you are being asked to guarantee the debt. If the borrower does not pay, you will have to. You could be required to pay the entire amount of the debt in one lump sum, plus any late fees or collection costs. So before you sign, make sure that you can afford to pay this amount if you have to.

Some studies show that three of every four co-signers ends up paying the loan. And when you think about it, this makes sense. If the primary borrower could qualify for the loan, then the creditor would not have required a co-signer.

If you do decide to co-sign, make sure you can afford to pay the loan. If you're asked to pay and can't, you could be sued or your credit rating could be damaged. Also, be aware that this loan will show up on your credit report, even if the primary borrower is making timely payments. This is a debt for which you are liable, so it will affect your credit rating.

Finally, ask the lender to agree, in writing, to notify you if the borrower misses a payment. That way you may be able to jump in and start making the payments without having to immediately repay the entire loan amount.

Tuesday, September 9, 2008

Freddie and Fannie - the Morning After

On Sunday, the federal government took over the management of Freddie Mac and Fannie Mae. Yesterday, the financial markets responded with hyperbolic glee. Pronouncements were made claiming this would save the real estate industry and, on Wall Street, stocks shot up over 300 points.

But today is the day after. And, in the light of this new dawn, people are starting to ask whether we really have our financial White Knight. Is this takeover going to save us? In a word - no. Will it help? Yes. Here's why.

Fannie Mae and Freddie Mac buy loans from banks and package those loans as mortgage-backed securities which they then sell to investors. By purchasing the loans from banks, the banks get their capital back which they then can use to make more loans. This cycle of lending money, selling the loan, and relending the money keeps funds flowing through the banking industry. In other words, there is money available for you to borrow. So what happened?

As concerns began to surface about sub-prime loans and higher-than-normal default rates, investors got nervous. They began to question the quality of the mortgage-backed securities that Freddie and Fannie were peddling. And then they started to question whether these mortgage giants would fail. Many stopped buying the securities and money stopped flowing through the system. Simply put, the money well dried up. That's why, for the past few weeks, even borrowers with great credit and good down payments were having a hard time finding money to borrow. And the money they did find was expensive.

Freddie and Fannie were on the verge of failing. And if they failed, the US financial industry would sustain a mortal wound. Fannie and Freddie are involved in $5.4 trillion worth of mortgage debt. Simply put, they are just too big for the government to allow them to collapse.

So the feds designed a bail-out. They replaced senior management and agreed to purchase $5 billion in Freddie and Fannie mortgage-backed securities. By keeping the companies solvent they are trying to restore faith in the system. They are trying to calm investors' nerves so that mortgage money will, once again, be available.

This will help some of us. Funds will be available to borrow, and the cost of borrowing will probably go down marginally. But it will not help people who have poor credit or a low down payment, so-called "A- or B paper" borrowers. It will not help people who do not have the equity in their homes to refinance before their interest rates increase.

Sunday's move was just a first step - a tourniquet to stop the heavy bleeding so that the patient did not die. It was not a cure. Over the next few months, you can expect to hear lots of opinions coming out of Washington and Wall Street as to what to do next. You can bet that, as with any serious illness, the cure will be long, painful and expensive. And the US taxpayer gets to pay the bill.

Sunday, September 7, 2008

US Unveils Takeover of Two Mortgage Giants

This article is from the New York Times, September 7, 2008


WASHINGTON -- The Treasury Department seized control of Fannie Mae and Freddie Mac, the nation’s giant quasi-public mortgage finance companies, and announced a four-part rescue plan that includes an open-ended guarantee from the Treasury Department to provide as much capital as they need to stave off insolvency.

At a news conference on Sunday morning, Treasury Secretary Henry M. Paulson Jr. also announced that he had dismissed the chief executives of both companies and replaced them with two long-time financial executives. Herbert M. Allison, currently chairman of TIAA-CREF, the huge pension fund for teachers, will take over Fannie Mae and replace the chief executive, Daniel Mudd. David M. Moffett, currently a senior adviser at the Carlyle Group, one of the country’s biggest private equity firms, will replace Richard Syron as chief executive of Freddie Mac.

“Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe,” Mr. Paulson said. “This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation.”

Mr. Paulson refused to say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be.

The companies are likely to need tens of billions of dollars over the next year, but the ultimate cost to taxpayers will largely depend on how and how fast the housing and mortgage markets recover from their current crisis.

Mr. Paulson’s plan begins with a pledge to provide extra cash by buying up a new series of preferred shares that would offer dividends and be senior to both both the existing preferred shares and the common stock that investors around the world already hold.

The two companies would be allowed to “modestly increase” the size of their existing investment portfolios until the end of 2009, which means they will be allowed to use some of their new taxpayer-supplied capital to buy up and hold new mortgages in investment portfolios.

But in a strong indication of Mr. Paulson’s long-term intention to wind down the companies’ portfolios, the Treasury plan states that they must shrink their portfolios by 10 percent a year until they each total $250 billion. They now hold more than $700 billion apiece.

That covenant in the agreement responds to many in the Bush administration and in the private sector who had argued for years that Fannie and Freddie posed “systemic risks” to the entire economy because they had acquired more than $5 trillion in assets with only the thinnest of capital cushions to shield them from losses.

Treasury officials had little choice. With the credit markets still in a tailspin and investors deeply reluctant to buy up mortgages with even a hint of risk, Fannie Mae and Freddie Mac currently guarantee about 70 percent of all new home loans, according to James B. Lockhart, the director of the Federal Housing Finance Agency.

Mr. Paulson said the Treasury Department would provide as much money as needed to keep the companies’ capital reserves from falling below the levels that would trigger rules that automatically put them into receivership.

In addition, the Treasury Department will create a “Secured Lending Credit Facility,” a back-up source of borrowing for the companies in the event they cannot borrow enough money on the open market to finance their main business of buying mortgages and re-selling them as pools of mortgage-backed securities.

In a possibly unprecedented move into their private markets, the Treasury Department will also buy up billions of dollars in Fannie and Freddie mortgage securities on the open market. This move is likely to make it much easier for the companies to finance somewhat riskier loans.