Practical real estate financing advice that can creat wealth

Another Announcement calmed fears in the financial markets. The Office of Federal Housing Enterprise Oversight, (Makes me wonder how do they come up with these names?) Just announced that they just  lifted a capital restriction they kept Fannie Mae and Freddie Mac that kept them from buying to much mortgage bonds, or some other restriction I do not know exactly-what it was, that is now lifted thereby making available yet another 200 Billion dollars for the mortgage market.

In My yesterdays post I mentioned the feds are not responsible for making the mortgage market better but for the general economy in all market as a whole. The Announced by the OFHEO is a measure that exclusively impacts the mortgage market, Just like the TSLF mentioned in my previous post

Make it a great day!

Sincerely

Joel Silberstein

The feds Primary Job is to monitor and control to some extend the economy as a whole. there job is not just to provide low interest rates to the housing market.

One of the ways the fed can stimulate the economy is by cutting their rates. By cutting their rates money is cheaper so banks can borrowand lend out. Not necessarily for home-loans but for business loans, etc.  If there is more money available housing will enjoy something as well.

The side-effects of a rate cut is

• the potential loss of value to the dollar.
• Inflation
• and higher mortgage rates.

Benefits of the rate cut is primarily for

• Commercial banks that are in business of checking and savings type of banking.
• Home equity loans that are typically have a 10 year life.
• Auto Loans
• credit cards.
• Business loans

As I wrote above the benefits are intended for the economy in general and not necessarily to the housing market. The housing market can initially suffer by getting higher interest rates due to bonds being enemy #1 of inflation.

An example-of a recent fed move to benefit the Housing market exclusively was the Treasury Securities Lending Facility introduced for the first time last week.

It is Amazing what is happening in the financial markets.

History repeat itself. Well it surely does, but not always exactly the same way, and not always to the same people.

There is a well known proverb that a smart person learns from everyone and everything around him.  By learning from some else's mistakes. He spares the painful ordeal of experiencing it himself.

A Quick look at History

During the great depression, banks where foreclosing houses in record numbers. Taking away the homes of good paying Americans, people who were on time with their bills were stripped of their homes since the banks who where lending the money where short on cash, because investors withdrew all of their money from the banking system due to the stock market crashing and the investors had to pay back money they borrowed to invest. With the banks being out of money they had no choice and they called all  their loans due.

On the news today is Bear Stearns. What's happening now is sort of the same thing that happened in the great Depression. Bear Sterns was in big trouble due to having a lot of exposure to the sub-prime loans that generated great loses. and as investors lost confidence in bear Stearns, that created a run on the bank situation, where investors are rushing to withdraw their money from bear Stearns, only to further exacerbate the liquidity crisis (shortage of cash).

What does this mean to the Consumer

This means that there is going to be a lot less money available to consumers in terms of loans, despite the feds cutting rates. Since money is primarily available to consumers by lenders like bear sterns or Fannie Mae, who get their money from individual investors and not from the government. If investors lose confidence in mortgage back securities, there will be a lot less of it and that means less money for real estate loans even if the fed cut rates. With the fed cutting rates that will be a good infusion and temporary cushion, however not the complete solution.

Action item for this market

Is to realize that the house /equity is not  the best place to keep your money in. First of all, it is  because you are essentially locking your money into an asset where you cannot withdraw it from there only in a lending favorable situation, or in times when there is a credit crunch or liquidity crunch. In times like these when lenders don't have cash, (like Bear Stearns) you are not going to be able to cash out! Even if that means not sending your son to collage, even if that mean money for a liver transplant!

Second reason why equity is not the best place to store cash, is because you are not diversifying your risk. Real estate markets are directly related to the lending and interest rate environment. If it is harder to finance , prices come down. That means keeping your money in a vehicle that might be in a depreciating state when you need it most. But by diversifying your equity instead of paying off one house, you have a better chance of having the money available when you need despite temporary market depreciation.

Lets learn from the lenders who weathered the storm, They weathered it by diversifying their assets. Lehman the close rival and competition to Bear Stearns is well positioned. They have a line of credit of 2 Billion dollars! And they achieved that by diversifying their assets globally, and in many different market unlike Bear Stearns who primarily focused on Mortgage Backed securities in the US.

Action Items in summary,

Do not dump all your money into the house, Instead diversify throughout markets and international markets.

The reasons are

•1.       Because you want to remain liquid regardless of lending landscape

•2.       Because you want to diversify your assets in order to diversify your risk (like Lehman)

There are many more reasons but to start out with these 2 is quite powerful!

Click here for the LA Times Article

Call me if you would like to weather proof your situation .

By the time I was done with proofreading this article, Bear Stearns was already acquired by JP Morgan Chase for pennies on the dollar.

I get quite often calls from my clients and Realtor partners every time the fed cuts rates (more often than not these days) asking me Is it a good time to refinance now since rates should be lower due to the recent cuts?

The answer is it depends, how do you like that for an answer!

It depends on Inflation and the reason for that is,

Would you lend  your cousin or friend $ 5000 for him to repay you $4,250?

That's exactly what inflation does to money; it takes away buying power and 5000 dollars in 5 years is just like $4250 dollars now, assuming a rate of inflation of 3% over 5 years.

Since a mortgage is a pledge from the borrower to the bank to repay their money in a 30 year period time, it better be worthwhile for the bank to wait until they get back their full amount. Now if inflation is at 2 % a year (the level at which the feds try to keep it) that means the dollar is worth 2 years from now 98 cents instead of 100 cents. That means Take 30 years (the time it takes to pay off a mortgage) X 2% (rate of inflation) =60. What that means is, that by the time the mortgage is completely paid off the money is now worth 60% less then at the time the mortgage started out.

To hedge them against inflation, lenders typically charge an interest rate high enough to cover profit in addition to inflation.

But when inflation becomes higher or unpredictable the lenders will have to charge an even higher interest rate.

Reasons for inflation includes a cheaper dollar IE, when the feds cuts the rates it charges banks, Then the dollar is easier to get for a much cheaper  price, thereby increasing inflation rates thereby increasing Mortgage rates.  Therefore we conclude that the feds have no direct influence on long term Mortgage Rates

For a longer version of this answer click herefor Bernanke explanation.