Advantages of credit cards
With the current credit crisis looming along with record credit card debt by American consumers, it’s tempting to write off credit cards completely. There is little doubt that carrying high credit card balances can quickly turn into a complete financial disaster, but responsible use of credit cards can carry many advantages. Here are some of the main advantages that credit card holders enjoy:
CREDIT CARDS CARRY A LEVEL OF CONSUMER PROTECTION THAT IS NOT OFFERED ON DEBIT CARDS
Many consumers are under the false impression that the same level of consumer protection exists on both credit and debit cards. This is not true, and in many situations the consequences can be devistating. Consider these facts:
* Debit card purchases can typically only be challenged if the card or card number was used without permission. In other words, if a debit card is stolen, the charge can typically be challenged and removed, pending an investigation. However, if the cardholder did authorize the purchase but was overchaged, the bank issuing the debit card will typically not remove the charge. At this point, the dispute is between the cardholder and the merchant, which may require a significant amount of time to resolve (if it can be resolved at all). A credit card company will typically remove a charge and negotiate with the merchant directly. Although there’s no guarantee that the dispute will be resolved in the cardholder’s favor, the card issuer does most of the work to resolve the dispute.
* A credit card is a line of credit and not actual cash. If a fraudulent transaction occurs on a credit card, a consumer has not actually been deprived of any real money. The only thing affected is the amount of available credit. If fraud occurs on a debit card, actual cash is removed from a bank account. If this happens to be the same account that the consumer’s mortgage, car payment and other household payments come from, the consequences can be many bounced checks and NSF fees. What would you rather deal with? An empty bank account or a credit card that’s over the limit?
* Credit card companies will sometimes offer additional protection if something is lost, stolen or damaged. The level of this protection varies from one card issuer to the next, so ask for details.
CREDIT CARDS ARE REQUIRED FOR MANY TRANSACTIONS
Car rentals, airline reservations, hotel room reservations and most online purchases are just some of the many examples. Although a debit card can be used for many of these transactions, the level of consumer protection is limited, as stated above. Consumers put themselves at greater risk by using debit cards for these transactions.
CREDIT CARDS HELP TO BUILD A SOLID CREDIT HISTORY
This is, perhaps, the best reason to have a credit card. With the current mortgage crisis only escalating, lenders are demanding higher interest rates for borrowers with lower credit scores and are raising the minimum credit score requirements for all types of mortgages. There are many ways to use credit cards in a responsible manner that maximizes the credit score. In addition to score requirements, most lenders require a borrower to have at least three accounts that are open and active on their credit report. Although they carry the Mastercard or Visa logo, debit cards do not help build a credit history and do not report to the three major credit bureaus.
SOME CREDIT CARDS CARRY SPECIAL BENEFITS AND BONUSES
IN addition to the benefits listed above, many credit card companies offer additional benefits, such as discounts on various products and services, points that can be used for airline miles, and special insurance and warranties for products.
And, of course, it wouldn’t be right to list the advantages of credit cards without also listing the disadvantages. The biggest disadvantage is the financial trap that many consumers fall into by using credit cards to live above their means. They simply provide an easy way to spend money that you don’t have. Also, credit card balances accrue with compound interest, so it’s never a good idea to carry a large balance on a credit card. Credit card companies have been equally as responsible as consumers for the overwhelming amount of debt that has accrued on the balance sheets of many American families, but it’s important to not miss the trees on account of the forest. The key is always RESPONSIBLE USE. If you can’t afford it, don’t buy it!
So what if you’ve had some credit problems in the past and can’t seem to get approved for a credit card? Consider applying for a SECURED CREDIT CARD. Secured credit cards can be obtained by almost anyone, regardless of past credit history. The only catch is they require a security deposit equal to the amount of the credit line. Simply put, if you want a secured credit card with a $500 credit limit, you’ll have to give the card issuer a $500 deposit. This deposit is not a fee; it’s credited as a savings deposit into an interest-bearing account. But you can’t withdraw the money as long as you keep the credit card (until the card issuer feels that a good payment history has been established, which is usually 12-24 months). If the money is needed prior to this time, the card issuer will return the money and close the credit card account, provided the full balance on the credit card has been paid.
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Secured Credit Cards
Many people who have gone through financial setbacks have struggled to rebuild their credit. The reason is simple: lenders are reluctant to extend credit to consumers with low credit scores, outstanding collections, past bankruptcies, etc. So what’s the best option for a consumer with a low credit score due to past credit problems? Apply for a SECURED CREDIT CARD! Secured credit cards are, hands down, the BEST WAY to re-establish credit and restore a good credit score. Most consumers have never heard of secured credit cards mainly because few banks have a vested interest in promoting them and many bankers simply don’t understand the fundamentals of how credit scoring works. Furthermore, unscrupulous credit repair companies rarely take the time to counsel their clients on how to re-establish credit and mainly focus on how to remove old derogatory items from their credit files. Although cleaning up old collections and charge-offs can indeed help raise the score, failure to RE-ESTABLISH new credit will keep the score lagging behind for years.
In other words, simply removing and/or paying old collections and charge-offs will not magically make the credit score raise high enough to qualify for a mortgage and/or many other types of consumer loans. New credit must be established in order to raise the credit score. Many people make the mistake of financing cars they do not need at ridiculously high interest rates in order to achieve this, when simply getting a secured credit card with as little as a $300 limit will do the trick over time.
How is a secured credit card different from a regular credit card? A secured credit card is, well, SECURED by a savings deposit equal to the amount of the credit limit and is held by the bank as collateral for repayment. In other words, give the bank $300 and they issue a credit card with a $300 limit. If the cardholder runs up a $300 balance on the credit card and defaults, the bank keeps the $300. It’s basically a no-lose situation for the bank, which is why practically anyone can get a secured card, regardless of credit history. If the cardholder keeps the account in good standing, the $300 remains in a savings account, and even earns interest. Typcially, most banks will release the security deposit back to the cardholder once they’ve proven their creditworthiness by making timely payments on the account for a period of 12-24 months. They will even, in many cases, raise the credit limit once this good payment history has been established. It’s important to note that the $300 is not a “fee”, it’s a “deposit” and it still belongs to the cardholder. The only way this money can be lost is by defaulting on the credit card per the cardholder agreement.
But what happens if an emergency arises and you need the $300? The bank will return the security deposit as long as the full balance on the card is paid in full and the cardholder agrees to close the account. The only way to lose the money is by defaulting on the credit card balance.
Underwriting guidelines for mortgages have tightened up significantly in recent months, and may continue to contract for many more months, even years. It’s NEVER been more important to have a good credit score when applying for a mortgage. FHA and Fannie Mae require a minimum of three tradelines that are open and have been active within the last twelve months in order to meet the minimum standards to qualify for a mortgage. In the past, it was relatively easy to use non-traditional credit references, such as letters of credit from utility companies, etc, to meet this requirement. But now many lenders are either imposing much higher interest rates for using this non-traditional method, or have stopped allowing this altogether. So it’s never been more important to build up a good traditional credit profile prior to applying for a mortgage. One nice feature about a secured credit card is the account stays open indefinitely unless either the cardholder or credit card company closes the account. Installment accounts, such as personal loans, automatically close when the term of the loan matures. In other words, once a 12 month installment loan is paid off, the account closes and this no longer counts as an open and active account, which reduces the long term impact on the credit score. (For more information on this, read about HOW CREDIT SCORING WORKS.)
So in conclusion, a secured credit card is a wonderful tool to increase both credit score and the overall likelihood of qualifying for a mortgage. As a loan officer, i can not guarantee this will result in a loan approval, but i CAN guarantee that not taking action to re-establish credit will significantly hinder the chances of qualifying in the future. The BEST way to re-establish credit is through secured credit cards. This, combined with managing credit, will make a huge difference in the shortest amount of time possible.
Appraisals
A real estate appraisal is a professional opinion of the market value of a property. The property that is the subject of an appraisal is called a subject property. The estimation of value is important to both the lender making the loan as well as to the homebuyer to ensure the sales price is an assurate reflecton of a the market value.
Appraisers are licensed by the State of Texas after completing classroom hours as well as internship hours that familiarize them with the local real estate market. Typically, the lender orders the appraisal once the home inspection is complete and any repairs that need to be done to the home are negotiated between the buyer and the seller.
What information is shown on an appraisal report?
* Specific details about the subject property. These are shown on a grid alongside at least three other comparable homes (comps) that have usually sold within the last six months and are in close proximity to the subject property. Appraisers are required to use comps that are generally similar in age, size and type of construction to the subject property. If no recent comps exist, the appraiser may have to use comps from outside the subdivision.
* Details about the neighborhood characteristics, including lot size, type of area (subdivision, on acerage, etc) and statements about the overall real estate market in the area.
* Any major items that may be defective, in need of repair, or may pose a safety hazard to the occupants. An old roof that needs replacing or a foundation in need of repair would be an example.
* Statements about issues which may positively or negatively impact the resale value of the property.
* Interior and exterior photos of the subject property and exterior photos of the comps.
What method is used to calculate the value?
There are two methods of calculating value-The Sales Comparison Approach Method and the Cost Approach Method.
The Sales Comparison Approach Method is calculated by making adjustments in the value of the comps based on the factors of the subject property. In other words, they make a mathematical estimation of what the comps would have sold for if they had exactly the same charachteristics as the subject property. This is necessary since no two properties are exactly the same. The full list of adjustments is summarized in a grid, usually located on the first few pages of an appraisal report. A normal appraisal will have three comps, but more comps are sometimes required by the lender depending on the circumstances. Lenders consider this method as the true value of the property.
The Cost Approach Method is an estimate of how much it would cost to rebuild the property if it were destroyed. This method is typically used by insurance companies to determine the amount of coverage that needs to be placed on the property.
AN APPRAISAL AND INSPECTION ARE NOT THE SAME THING ! ! !
Many buyers assume that an inspector and an appraiser are one in the same. They are not. Although an appraiser will note any obvious problems that they happen to notice, they do not perform a detailed inspection of the property. An appraiser’s main function is to determine value, not overall condition. A home inspector performs a much more detailed inspection of the property, and provides a report that summarizes all items that need to be repaired, replaced or serviced. They also serve to warn the buyer about conditions that may cause future problems that are not yet obvious. Although lenders do not require a home inspection, buyers should always have one performed.
What are mortgage backed securities?
Mortgage backed securities (MBS) are pools of mortgages that are sold as bond-like financial instruments to investors in the open market, also known as the “secondary market”. Although many banks and lenders participate in the sale of mortgage backed securites, there are two companies that control a combined total of 90% of this market in the U.S.-The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Mortgage backed securities offered for sale by these institutions are also known as ”agency bonds”. They purchase mortgages from banks and mortgage lenders, pool them into mortgage backed securities, and offer them for sale to investors from all over the world. Without this market, the banks would literally not have enough money to keep up with the demand for mortgages in the U.S. This market allows banks to sell this debt into the open market, thus replinishing their supply of money to loan to new borrowers.
The majority of investors that purchase mortgage backed securities are foreign. They may include various institutions, governments, and sometimes individuals. Mortgage backed securities are rated according to a variety of risk factors, which affect the price.
The two main components are price and yield, which are inversely related. When one rises, the other automatically falls.
Fannie Mae was established by FDR as part of the New Deal in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing. As a result of the housing collapse caused by the Great Depression, banks were unwilling to loan money for home financing. They initially provided money to banks for the purpose of providing home financing toperate as government sponsored entities (GSEs). Although they are privately held corporations with shareholders, they also enjoy the backing of the federal government. Their main purpose is to serve as the chief market makers for pools of mortgage backed securities. They purchase pools of mortgages from banks and then turn around and sell them on the secondary market to investors from around the world. Their portfolio of securities is an astonishing 6.2 Trillion dollars. That’s 46% larger than the largest bank Although most people have never heard of this term, today almost every mortgage made in the United States is pooled into and sold as one of these securities. Without the ability to raise capital by selling these loans, banks would literally not have enough money to lend to new homebuyers.
A home buyer used to have no choice but to pay a large down payment (usually at least 20 percent) and would borrow the rest of the money needed to buy the home from a bank. The bank loaned them money they had taken in from the general public-money that was deposited into savings accounts, CD’s, and so forth. The bank’s profit was in the spread (difference) between the amount of interest they paid to their depositors versus the amount of interest they would charge to the home buyer. One of the main problems of this “old fashioned” way of making mortgage loans is that banks simply do not have enough money to lend to enough homeowners to keep up with consumers demand for housing.
In 1938 as part of the “New Deal”, the Federal National Mortgage Association (Fannie Mae) was created for the purpose of raising money from foreign investors to loan as mortgages. Since Fannie Mae was a government sponsored entity, it allowed them to borrow money from investors at very low rates of interest and loan sing and a government goal to increase home ownership meant that a system had to be created to raise the capital needed to finance this expansion. The investment bankers on Wall Street saw an opportunity to create an investment vehicle that would serve two purposes. First, it would free up much needed capital for the banks to loan for new mortgages and second, it would harness the vast sums of investment capital from around the world and draw them into the U.S. housing market. This was the birth of the mortgage-backed security.
If this concept sounds vaguely familiar, that’s because it’s very similar to how the government raises money to operate through the sale of U.S. Treasury Bonds. While T-Bonds are backed by the full faith and credit of the U.S. government, mortgage-backed securities are backed by the collateral of the real estate by which they are secured. Additionally, some are also backed by either private mortgage insurance companies (PMI) or the Federal Housing Administration (FHA loans) or the Veterans Administration (VA loans). Generally, home buyers who have less than 20% down must either pay monthly PMI, a lump-sum PMI payment (also known as lender paid PMI) or they must take out a second mortgage to avoid having to pay PMI. PMI is basically insurance that protects the MBS investor in case the homeowner defaults on the mortgage. Without this insurance, investors would demand a higher rate of return and thus the rates for mortgages would be much higher.
Today, with the exception of a very few banks that keep specialty loan programs called portfolio loans on their books, almost all mortgages are pooled and sold as mortgage-backed securities. The recent economic crisis triggered by sub prime loans has not changed this fundamental fact. Even though many people still make their payments to a bank, that bank quite often doesn’t own the actual mortgage debt itself, they just own the servicing rights to the loan. The homeowner may never have a clue who actually owns their debt because the investor usually has no interest in servicing the loan, they are just looking for an investment vehicle. The mortgage servicer handles all the servicing aspects of a mortgage loan, including:
* Maintaining a customer service call center where homeowners can call when they have questions about their loan.
* Managing the escrow account on a mortgage, including paying taxes and insurance owed by the homeowner but collected as part of their monthly mortgage payment, as well as adjusting the payment if the cost of taxes or insurance changes.
* Providing payoff statements to title companies, lenders and homeowners when they want to refinance or pay off their loan.
* Collecting the monthly payments and forwarding that money to the investor (a.k.a. the owner of the mortgage backed security)
* Providing the homeowner with monthly payment statements or automatic draft of their payment from their checking account.
Once a homeowner pays off their mortgage, this money is credited back to the balance of the MBS. This is one major difference between a mortgage backed security and a traditional bond, such as a T-Bond or a municipal bond. Bonds have a specific maturity date (a specific date at which the principal balance will be repaid to the bondholder) whereas the date that homeowners will pay off their mortgage is uncertain. Only a very small percentage of homeowners who take out a 30 year mortgage will actually wait 30 years to pay off the loan. Most will either sell their home, refinance their existing mortgage, or pay off their loan early. For example, an investor who purchases a mortgage backed security will likely not own that security in 30 years. An investor who purchases a T-Bond at inception may very well hold their investment until maturity. Most mortgage backed securities consisting of 30 year term mortgages will payoff in 10 years or less. So investors tend to treat these much the same as a 10 year bond, regardless of the fact that their maturity date is 30 years.
What controls mortgage rates?
No single individual or entity controls mortgage rates, so the more appropriate question would be to ask “What factors control mortgage rates?”
Before discussing the specific factors in detail that DO control mortgage rates, let us first discuss which ones DO NOT control mortgage rates. The most common misconception among consumers is that the Federal Reserve (The Fed) directly controls mortgage rates. This is absolutely not true. Unfortunately, the media and also some unscrupulous mortgage advertisements help to spread this misinformation to consumers, which only adds to the confusion. The Federal Reserve only has the power to control two key short term interest rates, known as the Federal Funds Rate and the Discount Rate.
Here’s a chart showing mortgage rates compared with the Fed rate over the last 10 years.
There is a broad pattern that exists between the two, but there is no direct correlation between the Fed rate and mortgage rates. Notice some specific examples:
* The spread (difference) between the Fed rate and the 30 year mortgage rate was half a point around the beginning of 2001. The Fed lowered rates from 6.5% to 1.75% over the next 12 months, but mortgage rates remained the same.
* From mid 2003 until mid 2004, the Fed held rates steady at 1%, but mortgage rates actually spiked by 1%, fell 1% and then rose again by almost 1% during this same period.
* From mid 2004 until mid 2006, the Fed raised rates from 1% to 5.25%, but mortgage rates were relatively unchanged during this same period.
* More recently, the Fed has lowered rates while mortgage rates have resumed an upward trend.
To understand the economic forces that determine mortgage rates, you have to first understand what happens to a mortgage after closing. Almost all mortgages originated in the U.S. are pooled into groups and sold as bond-like financial instruments (mortgage backed securities) on Wall Street, also known as the “secondary market”. Since these mortgage backed securities function much the same as bonds and have similar characteristics as bonds, their price is also influenced by many of the same factors that affect bond prices.
Now let’s look at the big picture in perspective. There are two major vehicles of investment – Stocks and Bonds. If you read my article on mortgage backed securities, then you already know that as an investment, they somewhat resemble bonds. Stocks and bonds tend to have an inverse relationship, meaning when one goes up, the other often goes down. Why? Investors tend to buy stocks when the economy is doing well, since the potential for proit is greater. Likewise, they tend to buy bonds when the economy is in a state of weakness. Although there are exceptions to this rule, this is typically the pattern. Picture a see-saw of money constantly shifting between the two based on the state of the economy (and investors’ PERCEPTION of the state of the economy). We all know that when stocks are sold, their share price goes down. But what about bonds? The same holds true for bonds. When investors buy bonds, their price goes up, and when they sell, the price goes down.
MORTGAGE RATES are a direct result of the YIELD of mortgage backed securities. When the PRICE of morgage backed securities RISE, the YIELD FALLS, which LOWERS MORTGAGE RATES. When the PRICE of mortgage backed securities FALL, the YIELD RISES, which RAISES MORTGAGE RATES.
So now you understand the basic fundamentals. Understanding the reasons why the prices rise and fall is a little more complex. Let’s take our above conclusions and review some basic moves in the economy that can have an effect on the price of mortgage-backed securities:
* Investors sell stocks and put their money into bonds, including mortgage backed securities. This typically causes mortgage rates to FALL since the demand raises the price, which in turn lowers the yield. Ironically, a lowering of the Fed rate often triggers a rush to buy stocks, which causes a bond selloff causing mortgage rates to RISE. So the next time you hear the Fed is about to lower rates, don’t assume that mortgage rates will follow suit!
* Prices of competing bonds, such as T-Bonds, T-Bills, and corporate and municipal bonds. All bonds are competing for the same investors, so their respective yields tend to influence one another.
* Economic indicators such as inflation, unemployment, GDP and even the National Debt.
* Investors’ perception of the overall housing market.
* Investor confidence in the ability of mortgage entities such as Fannie Mae, Freddie Mac and FHA to accurately determine risk. Lax underwriting standards of the subprime era have added to investors’ skepticism of the risk management ability of these entities.
As our economy continues to change, the factors that affect mortgage rates may change as well.
Always obtain the advice of a competent mortgage professional before locking a rate. Don’t assume that simple actions such as a Fed rate cut will automatically mean that mortgage rates will drop in tandem. The economy is much more complex than the media portrays on the evening news.
CONTACT JOHN JONES at (972) 978-3553. Licensed loan officer in the state of Texas (TX12304)
