Archive for January, 2013

5 Things to know when making extra loan payments

This is a good time to pay down your mortgage: One of the vexing features of the post-crisis financial system is the dearth of riskless investments paying a decent return. The rates on federal government securities and insured certificates of deposit (CDs) are not much greater than zero.

Yet every homeowner with a mortgage has the opportunity to earn a return equal to the interest rate on the mortgage, with no risk, simply by making extra payments. It is the best investment opportunity most homeowners have.

The only downside to using mortgage repayment as an investment is that it has no liquidity — once you make the payment you can’t take it back if you have an unexpected need for funds.

However, most homeowners with mortgages who place their savings in bank deposits or money market funds paying less than 1 percent, rather than earning 3-6 percent by paying down their mortgage, do it for reasons other than a need for liquidity. The main reason is confusion about one or another feature of loan repayment.

Confusion about loan repayment as an investment: Some borrowers have trouble viewing mortgage repayment as equivalent to buying a bond or a CD. Yet in both cases, you pay out money now and receive a stream of income in the future based on the contracted interest rate.

The only difference is that the income received from a mortgage repayment is cancellation of interest that you would have had to pay otherwise. The difference between receiving $1,000 of interest and eliminating the payment of $1,000 of interest is one of form but not of substance.

Those with a mortgage can actually earn a little more than the interest rate on their mortgage by taking advantage of the 10- to 15-day payment grace period that is found in all mortgage contracts. By adding the extra payment to the scheduled payment, the borrower will save interest for the entire month, even though he does not provide the funds until 10 or 15 days into the month.

Note: If the borrower makes a separate payment after the grace period, his loan balance may not be reduced until the following month, which would reduce his return on investment.

Confusion over deductibility: Some borrowers who itemize their tax deductions don’t want to repay their mortgage because it entails loss of a deduction. But the loss is exactly the same as that on a taxable investment. For example, a borrower in the 33 percent tax bracket who repays a 3 percent mortgage earns 2 percent after tax. If instead the borrower purchased a CD paying 1 percent, the after-tax return is 0.5 percent. If the before-tax rate on the repaid mortgage is above the before-tax rate on the alternative investment, the same will be the case after taxes.

Confusion over mortgage life cycle: Some borrowers believe that they missed the boat on loan repayment because they didn’t do it in the early years of their mortgage when the regular payment went largely to interest, whereas now most of it goes to principal. But the rate of return on mortgage investment is not affected by where the mortgage is in its life cycle. While the allocation of scheduled payments between principal and interest changes over the life of the mortgage, extra payments go entirely to principal, no matter what stage of its life cycle the mortgage is in.

Confusion over imminent sale or retirement: Some borrowers are immobilized by plans to sell the home, as if somehow this would prevent their obtaining the expected benefit from making extra payments. But it wouldn’t — in fact, the benefit would become glaringly evident in the smaller loan balance they have to pay off out of the sale proceeds.

A similar point applies to those planning to retire with reduced income. If and when they need a reverse mortgage in the future, they will have to pay off their existing mortgage in the process, and the lower the balance, the more they will be able to draw on the reverse mortgage.

Confusion over whether the lender will properly credit their account: Numerous versions have crossed my desk, including a concern that the lender won’t credit their account until the end of the term. This is not true — the account is credited immediately or even a few days early, as noted above.

A variant is that the lender will use the extra payments for some purpose other than reducing the loan balance. The only substance to this concern is that the lender will indeed apply extra payments to any unpaid obligations, of which the most likely is an underfunded tax/insurance escrow account. Aside from that, the only thing the lender can do with extra payments, other than credit them to the loan balance, is to steal them, which they never do.

With one exception, borrowers making extra payments need not provide special instructions as to how the payments should be applied. The exception applies when the extra payment is an exact multiple of the scheduled payment – the payment the borrower is obliged to make each month.

If the scheduled payment is $600 and the borrower sends in a check for $1,200, the lender does not know whether the borrower wants to apply the extra $600 to principal, or is paying for two months. To avoid this problem, do not make extra payments an exact multiple of the scheduled payment.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania.

Half of U.S. states saw an annual increase in the number of foreclosure-related filings in 2012, but most of those were judicial foreclosure states where loan servicers were catching up on the backlog from the “robo-signing” controversy, according to a year-end report by data aggregator RealtyTrac.

All told, RealtyTrac reported foreclosure-related filings against 1.84 million U.S. properties in 2012, down 3 percent from 2011 and down 36 percent from a 2010 peak of 2.9 million homes.
All but five of the 25 states seeing an increase in foreclosure-related filings (default notices, scheduled auctions and bank repossessions) were states where courts handle most foreclosure proceedings.

Many foreclosure proceedings against homeowners in those states were stalled, but not derailed, by allegations that loan servicers failed to follow proper procedures in filing legal documents.

After loan servicers reached a settlement last March with state and federal officials last over so-called “robo-signing” practices and revised their procedures, they began pushing new and existing proceedings through the system again (many also started approving more short sales to meet their obligations under the terms of the settlement).

Foreclosures are handled by courts in the six states seeing the biggest annual increase in 2012 foreclosure filings — New Jersey (up 55 percent), Florida (53 percent), Connecticut (48 percent), Indiana (46 percent), Illinois (33 percent), and New York (31 percent).

Homes in New York took the longest to move through the foreclosure process — 1,089 days — followed by New Jersey (987 days), Florida (853 days), Hawaii (781 days), and Illinois (697 days).

In the 25 states that saw foreclosure filings drop from 2011 to 2012, 19 handle most foreclosures outside of the court system, and loan servicers in those states continued to move homes through the foreclosure process during the robo-signing controversy.

Non-judicial foreclosure states seeing the biggest drop in foreclosure filings in 2012 were Nevada (down 57 percent), Utah (down 40 percent), Oregon (down 40 percent), Arizona (down 33 percent), California (down 25 percent), and Michigan (down 23 percent).

RealtyTrac warned there could be a foreclosure backlog building up some states that saw filings decline in 2012, as the result of new state legislation and court rulings that make it more difficult for lenders to foreclose.

So 2013 could see “two discrete jumps in foreclosure activity,” at the beginning and end of the year, said Realty Trac’s Daren Blomquist.

“We expect to see continued increases in judicial foreclosure states near the beginning of the year as lenders finish catching up with the backlogs in those states, and another set of increases in some non-judicial states near the end of the year as lenders adjust to the new laws and process some deferred foreclosures in those states.”

The rise in foreclosure activity in many local markets in 2012 “should translate into more foreclosure inventory available for sale in 2013 in those markets,” Blomquist said. “That is good news for buyers and investors, but could result in some short-term weakness in home prices as the often-discounted foreclosure sales weigh down overall home values” in those markets.

States with the highest foreclosure rates in 2012 were Florida (with filings against 3.11 percent of homes), Nevada (2.7 percent), Arizona (2.69 percent), Georgia (2.58 percent), California (2.33 percent), Ohio (1.75 percent), Michigan (1.69 percent), South Carolina (1.66 percent), and Colorado (1.64 percent).

Among metro areas with a population of 200,000 or more, Stockton, Calif., had the nation’s highest foreclosure rate (3.98 percent). Six other California cities made RealtyTrac’s list of the 20 metro areas with the highest foreclosure rates, and Florida landed eight cities on the list, including Miami (3.71 percent) and Orlando (3.46 percent).

Zillow is projecting that a half-dozen markets in California, including some Central Valley cities hard hit by foreclosures, will see double-digit home price appreciation in the months ahead. The real estate portal’s analysis of more than 250 markets predicts that national home prices will appreciate 2.5 percent in the year ending November 2013.

“The U.S. housing market bottomed in the fourth quarter of 2011 and has since entered a sustainable recovery,” Zillow Chief Economist Stan Humphries said in a blog post.

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