Saving on mortgage interest

Now that rates are on the rise, you’ll want to do everything you can to save on interest payments when you take out a mortgage for a new home. If you borrow $100,000 at 8 1/2 percent for 30 years, you’ll pay $176,809 just in interest over the life of the loan. Obviously, any portion of that amount you can divert to your retirement fund would be to your financial benefit.

To save on interest payments and build a more secure future, keep in mind one basic principle: The quicker you reduce the balance, the less interest you pay. This requires a consistent strategy to divert more payment dollars toward principal reduction and less toward interest.

Is paying off your mortgage always the best way to go? You’ll have to decide. For many homeowners, satisfying their mortgage is an important goal that goes beyond pure quantitative analysis. They want the security that goes with not having a monthly house payment. But for others, paying off an 8 1/2 percent mortgage is nothing more than making an investment with an 8 1/2 percent return. You won’t gain much financially by paying off your mortgage if you can get a higher return by putting extra cash into a mutual fund or other high-yield investment instead. But this strategy is riskier and takes a lot off effort in planning and tracking the performance of various funds.

For homeowners who want to build risk-free equity in their homes, we offer several alternatives to the 30-year mortgage that’ll take the bite out of interest payments.

Taking out a mortgage with a shorter term than the usual 30 years can give you more money for your retirement. The interest on 15-year loans is typically about 1/2 percent less than for 30-year programs, making them more attractive and easier to qualify for. The savings can be substantial. An 8 1/2 percent 90,000 mortgage over 30 years will carry an interest tab of $159,128 (see the table, below). Shorten the same loan term to 15 years and you will pay $69,528 in interest – a saving of $89,600.

The payments on a 15-year mortgage are not double that of a 30-year loan, but only 26 percent higher. (They’re less if you factor in the lower interest rate you’re likely to get on a 15-year package.) That means you don’t have to earn double the income to qualify for die shorter loan.

If you can’t quite handle the higher payment of a 15-year loan, a 20-year mortgage is a good compromise. The savings are still impressive. A $90,000 loan at the same 8 1/2 percent rate will save you $61,678 if you shorten the term from 30 to 20 years.

Tips if you’re looking for a home mortgage

Some tips to keep in mind when shopping for a mortgage:

* Don’t go for the cheapest price on the street. Mortgage packages vary from lender to lender, so look for other products and services, such as a line of credit, credit card, mutual funds, hidden charges and prepayment options.

“If you don’t like what one bank is telling you, go to another bank. It’s a competitive market out there,” says Tom Alton, president of Bank of Arizona Mortgage Corp.

* Think long term, before applying and choose Arizona VA Loans. Interest rates aren’t going to get much lower, says Andy Charles, vice-president of national sales with CIBC Mortgage Corp. So, lock into a five-year term if you’re a first-time home buyer.

You’ll have the security of knowing what your monthly payments are for the next five years.

* Get a pre-approved mortgage so you know what you can afford based on your income and fixed expenses.

* If you don’t qualify for a mortgage from a bank or trust company, ask for a referral to another company the bank may have a relationship with.

* Consider private sources such as relatives or a vendor-take-back mortgage.

* Check newspaper ads for small and private lenders who might be willing to take more risk than big banks and trust companies.

Tips to ensure car costs don’t wreck your budget

The American Automobile Association calculates that it cost an average of $3,100 last year to own and operate a car.

That figure is based on driving 15,000 miles during the year and includes expenses for gas, oil, tires, maintenance and insurance, as well as financing costs to pay an auto loan.

Expenses will vary depending on the kind of car you drive, how frequently you use it and the number of miles you drive.

The Virginia Society of Certified Public Accountants recommends that you shop carefully if you’re in the market for a new car.

The kind of car you purchase and how much you pay for it will affect annual operating costs substantially and may well put a bigger dent in your budget than you planned, the CPAs said.

Before making an offer on the car of your choice, find out the car’s invoice price – the amount the dealer paid for the car. Many auto and consumer magazines publish the dealer’s costs for all makes and models.

The same publications also can help you determine safety and repair records.

To arrive at a fair price, try to negotiate up from the dealer’s cost rather than down from the sticker price.

Don’t let a dealer persuade you to spend more than you can afford.

If you plan to trade in your old car, come to an initial agreement on a purchase price for the new car before negotiating the value of your trade-in, the society said.

The Credit Union National Association advised buyers to shop for a car that fits their individual transportation needs. For example, ask yourself if you will be using the vehicle mostly for single-person commuting or as a general family vehicle. Stick to a car that meets your specific needs.

Calculate the monthly payment you can afford. The credit union group said your monthly auto payment, house payment (or rent) and payments on other debt should not exceed 40 percent of take-home pay.

Don’t overlook the fact that financing an auto loan is a major cost.

Given the high price of new cars today, the CPAs said, most people either turn to a bank or credit union for an Auto Title Loan.

Before selecting a lender, shop around for the lowest annual percentage rate. Then consider how the interest affects the total cost of the car over the life of the loan.

If you decide to finance a new auto through the dealer, the dealer may offer you a choice between a rebate and discount rate on the financing.

In most instances, the CPAs said, the rebate is a better deal. That’s because reducing the amount you actually finance usually reduces your total monthly costs more than lowering your interest rate.

Insuring your car is also vital and can be a considerable cost of ownership.

The CPAs said consumer-advocate researchers have found that automobile insurance companies charge different premiums for similar coverage.

To get the best deal, compare basic coverage carefully, then search out additional opportunities to lower your premiums.

Selecting a larger deductible is the first step in reducing premiums. Dropping comprehensive and collision coverage on an older car also can reduce your insurance cost.

Most companies offer premium discounts for multi-car policies, cars equipped with anti-theft devices, accident-free and violation-free drivers and drivers who car pool. To be sure you’re getting the discounts you’re entitled to, ask your insurer for a complete list of available discounts.

In calculating the cost of owning a car, you must also consider depreciation – the amount by which your car’s value will decline during a specific period. Remember that your car’s value declines more rapidly in the first few years.

To estimate your annual cost for gas, divide the total number of miles you drive in a year by your car’s average miles per gallon, and multiply by the average cost for a gallon of gas.

When computing your cost for oil consumption, add the cost of every oil change, as well as any oil you add between changes.

Maintenance refers to the periodic servicing specified by the manufacturer. Taking the manufacturer’s recommended preventive steps can help you keep your car running properly.

However, even with proper maintenance, your car is likely to need repairs from time to time.

Be sure to get referrals in selecting a car mechanic or auto body shop. Consider looking for a mechanic who is certified by the National Institute of Automotive Excellence, called ASE certification.

In tallying up your automobile costs, don’t forget to add fees for your driver’s license, vehicle registration and safety inspection, as well as what you pay in personal property taxes, tolls and parking over the course of a year.

All of these expenses will fill just that one line called transportation on your overall household budget.

How to get financial planning information for students

Operating on a tight budget is a necessity for most college students. Post-secondary education is expensive: a university degree can cost tens of thousands of dollars, based on two years or more of paying for tuition, books and supplies, computers, accommodation, clothing, transportation and only modest entertainment.

Even if a student has money from student loans, savings from a summer job, a parental contribution and ongoing income from part-time work, getting by often isn’t easy. Having just left the the family nest, the first semester of post-secondary education represents a crash course in financial planning – especially for those who have left the family nest for the first time to attend school elsewhere.

While parents can provide guidance, there are other sources of help. Some universities offer basic budgeting advice through an on-campus services.

“We provide students with assistance in planning budgets, preparing appeals and managing their financial resources through individual counselling,” says Doreen Whitehead, director of the University of Western Ontario’s financial aid office in London, Ont.

Whitehead’s office is Western’s administrative centre for student loans and other government aid programs, such as the Ontario Work Study Program, as well as the university’s bursaries and loans. “A reception area is available where students can submit forms, get applications, get appeal information and answers to routine questions,” she said. The office also has staff to handle more complicated inquiries.

At Montreal’s Concordia University, students have access to free in-depth counselling on personal budgeting and debt management. “The goal is to help students make better-informed decisions about the debt they take on as students,” says Roger Cote, director of Concordia’s financial-aid and awards office.

Students have an initial half-hour consultation to help them establish a reasonable financial plan for their university years.

The program’s ultimate objective, however, is to help students avoid a debt crunch after they graduate. “We help them make the right decision about their loan situation,” Cote said. That decision is influenced heavily by projections of what the student’ financial situation will be when he or she enters the job market.

Cote has developed spreadsheets that allow counsellors to plug in an array of income and expense data to help the student determine what is a reasonable debt load when time comes to repay education debts.

Off campus, bank branches are a good place to seek financial-planning information. Some banks have easy-to-read booklets offering information on loans and other financial aid, budgeting, banking, credit use and income tax.

B of M’s U-Choose: A Student’s Guide to Financial Survival has 30 pages that cover the basics as well as sections on food shopping, economical transportation, computer buying and even interior design. The booklet is free to students at the bank’s branches and at some college student-aid offices.

Massachusetts banking: A Student Loan Private Chioise Information is a 2-page freebie that focuses on banking-related financial matters.

Some money-management tips for students gleaned, in part, from booklets available from Bank of Montreal and Bank of Nova Scotia:

Budgeting: If you’re sharing accommodation and expenses, sit down regularly with your roommate(s) to review the budget and make changes to it.

Before you go: Check out the cost of living in the area near your school, and adjust your budget accordingly. If you have a scholarship, bursary of grant, make sure you keep receipts for moving expenses – these costs can be claimed as tax deductions.

Entertaining: A home-cooked meal will cost you a lot less than the restaurant variety. What’s more, adds Bank of Montreal booklet, “depending on your culinary skills it may be a hit by other standards as well.”

Payday loans have become popular

The payday loan business boomed again in Colorado last year, according to new figures from state regulators.
After more than doubling between 2007 and 2008, short-term loans with interest rates up to 100 percent grew by about half last year, the Colorado Attorney General’s office reports. The increase locally is part of a nationwide explosion, reported by The Denver Post in May, in “fringe banks” that cash checks and make loans of last resort.

In Colorado, about 150 lenders now offer unsecured payday loans that usually must be repaid in about two weeks. In 2000, the state had fewer than a dozen payday loan stores.

Simple and fast
Getting a payday loan is simple and fast, as long as you have a job and a checking account. For a flat fee of $25, the most allowed by Colorado law, lenders and borrowers trade checks. The lender’s $100 check is good immediately; the borrower’s $125 check is post-dated, usually for about two weeks.

Still, the industry continues to grow.
Lenders made more than 230,000 small, short-term loans in 2010 with an average interest rate of almost 300 percent, according to the state. The loans totaled about $27.2 million, with an average annual interest rate of 278 percent.

That’s up about 50 percent from 2008, when lenders made 175,000 loans for $18.5 million, with an average interest rate of 369 percent. The interest rate fell between 2008 and 2010 because the average loan size increased slightly, while fees remained about the same.

As loans rose last year, defaults also soared, the state reported. In 2010, borrowers failed to repay about 8,900 loans, up from 5,700 defaults in 2008.

No complaints

Laura Udis, head of the state agency that regulates payday lenders, said her office has not received any complaints from consumers about the loans. “It’s a business with a very loyal clientele,” Udis said.

Udis said that because of a new law, her office will no longer examine every payday lender every year. Instead, regulators will check lenders only on an “as needed” basis, she said.

State usury law imposes strict limits on the interest rates for most loans made in Colorado. But the law contains an exception for small loans: Instead of charging interest, a lender can set a flat fee of up to $25, or 25 percent of the loan amount, whichever is less, to cover his costs.

Loans for small business

Until a few years ago, large institutions had few advantages in lending to small business. Loans were made to small commercial customers in more or less the same fashion as to large corporations: Each loan was considered unique, and there were few economies of scale. Borrowers had to supply detailed information about business plans, balance sheets, cash flow and profits. An underwriter painstakingly reviewed the data using procedures that were time-consuming and costly. And because the prospects of a small enterprise are so difficult to judge, conventional wisdom held that credit decisions couldn’t be made from far away. Only a local banker with knowledge of the area could accurately size up a borrower’s credit-worthiness.

Many large banks have had a history of on-again, off-again interest in small business. When opportunities in the corporate sector were scarce, managers would order the troops into the small-business market. But no one could figure out how to make a buck by lending small amounts to small business. It was like cars in the days before Henry Ford-no one could afford one because each was hand-made.

But computerized technology permits-in fact demands-mass production. As a result, a growing number of large banks and nonbank financial institutions have tossed out their old rule books and stopped treating small businesses like pint-sized versions of their corporate customers. Fundamentally, the small business customer is a retail customer.

In making credit decisions, major lenders have started to apply to small business the statistics-based methods long used to review consumer applications for credit cards and mortgages. With credit scoring, as the system is known, lenders no longer need to perform a detailed financial review of each borrower. Instead, they pinpoint a few key pieces of information that assess the statistical probability that a borrower will repay, such as a business owner’s record in paying off personal debts.

The applications are processed in loan factories in which assembly-line techniques are used to drive through large volumes. The new processes trim application processing time to as little as 15 minutes and lower the cost of making Nevada payday loans from thousands to hundreds of dollars. That makes it profitable for lenders to offer business credits in amounts as small as $5,000. It gives them the option of offering cut-rate prices to generate business. And it allows them to shrink applications to the size of a credit card form.

Credit-scoring technology has been used on consumer loans since the 1960s, but until this decade no one had collected the large volume of data on small business credit behavior needed to develop statistically reliable predictive models. It wasn’t until the early 1990s that vendors began making small business scoring systems commercially available.

Credit scoring, of course, is available to community banks as well as big regionals. But small institutions don’t have enough loans on their books to manage credits on a statistical, or portfolio, basis. A portfolio lender monitors delinquency rates rather than individual credits.

For this reason, there is a basic difference between the way big and small lenders use credit scoring. Large-scale lenders use it as a decision-making system, and applicants with sufficiently high scores generally get a loan. Community banks still use humans rather than computers to make credit judgments, but may use credit scoring to sort applicants, or as one of several factors taken into account in making decisions.


Q: What is “bad credit”?

A: “Bad credit” refers to a poor credit record, indicated by delays in paying bills or record of financial judgments, liens, bankruptcy filings or collection agency accounts.

Q: How can I research my credit record?

A: To get a copy of your file, call one of the three national computerized credit reporting agencies.

Q: What types of things show up on a credit report?

A: In addition to the “bad credit” items listed above, the payment history of every account you have will be reported to the credit reporting agencies.

This includes credit cards, department store charge cards, auto and home loans, and accounts with utility providers.

Q: How long does information stay on the credit report?

A: Adverse information remains on your credit record for seven years from the last transaction date. Bankruptcy filings, however, will stay on the record for 10 years.

Q: How will a mortgage lender perceive problems in my credit record? Are some types of credit problems worse than others?

A: Policies on how to evaluate a credit report will vary among lenders. Generally, a lender will look for any present delinquent accounts, then look for accounts paid off but very slowly. It is more damaging if the slow-pay closed accounts were recent. The older the delinquent information, the less damaging it is.

Bankruptcy is probably the worst derogatory item that could appear, in that it reflects character. It would in almost all cases cause a lender to deny a loan. A delinquency of 90 days in a payment, particularly if it occurred some years, ago, might be forgiven by a lender.

Lenders will likely question the record of an applicant with loans for bad credit and credit accounts beyond what the lender considers normal, say, six or more bank card accounts that are either current or inactive.

Q: How can I remedy problems in my credit record? When will a lender consider me a good credit risk?

A: More recent up-to-date accounts will mitigate some of the damage of older delinquent information.

If it’s difficult to get a credit card because of derogatory information on file or a weak employment record, it’s possible to get a “secured” bank card, which, if paid promptly for a period of time, will improve the credit file. The fact the card is secured by a deposit is not reported, therefore it will show on your record as a bank card (Visa or Mastercard) that is paid promptly. Most secured-card companies will return the deposit after a reasonable good-pay record is established and will continue the account as a normal unsecured account. The deposit earns interest, which is eventually returned to the depositor.

It is not recommended that you deal with a secured-card company that requires you to buy exclusively its merchandise.

A lender will consider you a good credit risk once recent accounts have been paid on a current basis for around a year, your employment record is stable and income capacity is ample to handle financial obligations.

Q: What can I do if the credit report is inaccurate?

A: The history of how you paid your accounts cannot be changed. The only exceptions are errors made by the creditor reporting the item or if the credit reporting agency places items on the wrong person’s file.

If you believe there is an error, write to the credit reporting agency asking for a correction. The agency then will request the creditor to verify the facts and if it is found to be an error, will ask that it be removed. This process should be resolved in 30 days. If there is a dispute (for example, the consumer says he returned the item but didn’t get credit and the creditor has no record of the return), the applicant can submit a short statement to the credit reporting agency, fewer than 100 words, setting forth his side of the dispute. Any future credit reports obtained by a prospective creditor will contain that statement. However, the prospective creditor will use judgment on the veracity of the consumer’s statement.

Q: Should I consider a visit to a “credit doctor”? Where can I go for reliable credit counseling?

A: Paying money to a so-called “credit doctor” to eliminate a derogatory item is throwing money away. If there is truly an error, the consumer can correct it as described above, without any cost. If it’s not an error, it will not be removed.

GAAP Tightens Loan Losses, But Where’s The SEC?

The issue of whether banks are using their loan loss reserves to manage earnings reached an uncomfortable point for bankers last week when an explanation of the relevant generally accepted accounting principles (GAAP) was posted on the Internet. In fact, it appears banks have loosely interpreted the rules, but the Security and Exchange Commission’s ruling on their accounting behavior may be awhile.

The issue is of particular importance to banks, which were once viewed as very volatile in terms of earnings due to their dependence on interest rates. Banking regulators gave the go-ahead to build up reserves several years ago, providing banks with a cushion when unexpected losses occur. Last fall, the SEC questioned the legitimacy of those cushions, and then backed off when the industry cried unfair.

Last week, Financial Accounting Standards Board posted an article on its Web site interpreting financial accounting statements 114 and 5. While there is still room for a special task force from the American Institute of Certified Public Accountants (AICPA) to clarify how to reserve for possible bad loans and remain within GAAP, the FASB staff’s interpretation provides guidance that industry sources said was not apparent to bankers before. An example is the observation that a loss must be incurred before it can be written down, which sources said is generally not the approach today. Instead, there now is a liberal interpretation of FAS 5, which holds that a loss has occurred once a borrower enters prolonged financial trouble, not when bankruptcy occurs.

"It could have a serious effect on the amount of allowances banks could have. This comes out hours or days before people put out first quarter earnings and file 10Qs," said one source at top-five accounting firm.

A FASB staffer said, however, that "nobody’s particularly arguing it needs to be applied retroactively."

Nevertheless, bankers contacted by Financial Modernization Report were eager to hear from the SEC, which ultimately enforces the accounting. SEC staffers said that the agency was waiting for someone–specifically, a bigfive accounting firm–to ask them for the guidance on when, how and by how much to revise allowances.

But even then it may be awhile before the SEC acts, according to staffers, because Lynn Turner, the chief accountant, has been out of the office, and because the issue is a complex one.

"This is going to take a couple of weeks. I haven’t fully thought this out. Usually those things are treated prospectively, or by cumulative catchup," where a bank recognizes the effect of the change in one line below net income and before cumulative effect on the financials. The staffer added that the possibility of restatement was practically nil. Further, he said, the staff might have to turn around and consult with FASB on the issue and even the top five accounting firms. "We’d really need to understand the extent of the problem before we come up with a solution," he said.

Meanwhile, the AICPA is scheduled to meet April 20 to continue studying implementation issues and work on a proposed statement of position on how to apply GAAP to loan reserves. The proposal must be approved by both FASB and the AICPA’s Accounting Standards Executive Committee.

Pascal Desroches, SEC accounting fellow and member of the task force, said the issue of when a loss is incurred may appear straightforward but, in fact, is complicated. As an example, he cited the differing opinions on a bank allowing for the default of a corporate borrower due to Y2K problems. "Some may say if the borrower hasn’t fixed the bug, then it’s a fair allowance. But some would say whether or not they fix this bug is a future problem; the company hasn’t gone bankrupt, therefore you can’t provide an allowance."

One controller at a major regional bank voiced a popular opinion when he said he hoped FASB’s interpretation merely means regulators are "sensitizing everyone to put more discipline in the process. We’re not going to change the world, but we’re going to control the current situation. We’ll keep an eye on you. You better tighten up your documentation (of the rationale for reserving for loans that have not defaulted yet but are expected to.)"

Capital Increases Weighed For Foreign Loans, Hedges

International banking supervisors are considering raising capital requirements on loans to developing countries and hedge funds, a senior regulator said recently.

The new system would use bond ratings to determine the capital charge on loans to sovereign governments, said Stephen C. Schemering, deputy director of banking supervision at the Federal Reserve Board.

Reserves would not be required for loans to countries with the top credit ratings, such as AAA or AA-minus, he said. Credits to countries with A- plus or A-minus ratings could carry a 20% risk weighting, he said. That means the bank would hold 20% of the standard 8% capital charge, or 1.6% of the loan, as a reserve. Countries with very low credit ratings could be subject to a 150% risk weighting, which translates into a 12% capital charge, he said.

International regulators also are considering a 150% risk weighting for loans to "highly leveraged institutions not subject to regulation," Schemering said during a workshop at the Independent Bankers Association of America convention. That is how regulators typically describe hedge funds.

The 150% risk weighting also would apply to "impaired" loans, though he provided little detail on what it would take for a credit to be considered impaired.

Schemering cautioned that the proposal is a draft and significant changes could be made before its expected release next month. Yet this would be the first time international regulators ever set capital requirements above 8%.

The capital proposal also would change the treatment of loans to other banks and securities firms, Schemering said. The reserve requirement would be one risk bucket higher than the capital charge for loans to the borrowing bank’s home country government, he said.

That means a loan to a U.S. bank would be subject to a 20% risk weighting. Mortgage loans would continue to fall into the 50% risk bucket, he said. Regulators plan to continue to require the full 8% reserve on all corporate loans, though Schemering said there is some talk of discounting the required reserve for loans to AAA-rated companies.

SEC Letter: Warning Or Threat?

The Securities and Exchange Commission’s recent crackdown on earnings management, reported widely several weeks ago, may be little more than a warning, but it may also be ammunition.

The agency sent a letter to select bank holding companies last month telling them that it might investigate their banks’ loan-loss reserves.

The SEC has let it be known that it is not happy with the generous loan-loss reserves banks have set aside for a rainy day, viewing them as a form of earnings management rather than healthy prudence, and so against generally accepted accounting principles (GAAP). The conundrum this creates for banks is that the banking regulators want to see the strong allowances. The situation came to a head this fall when SunTrust was required to restate earnings to the tune of several million dollars.

The letter, which was addressed to a generic "Chief Financial Officer," advised that the banks’ 1998 annual reports "may be selected for review." The language was so seemingly casual that some analysts saw it as an almost friendly admonition to follow GAAP.

"So it’s not a ‘we’ve looked at your charges and disagree with them’ (letter); it’s a kind of a reminder letter. I think long term this is just a friendly reminder, ‘The accounting rules are there, follow them.’ This is just pulling the boys in," said Hal Schroeder, senior bank analyst at Keefe Bruyette & Woods.

Other bank watchers were not so sanguine.

"This is like a comment letter in advance," said Michael Joseph, partner at Ernst & Young. "This could be ammunition for the SEC for those they feel haven’t complied, (the agency can say) ‘We told you already.’ These are things the SEC is looking to see in this year’s annual reports and I will expect banks to be criticized if they don’t comply."

Banks must file annual reports by March.