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  • Mortgage Payments by Credit Score

    A few months ago we posted on the effect your FICO (“credit”) score would have on your mortgage payment. Given turmoil in the credit markets we though it would be interesting to revisit that post.

    Example 30 year mortgage rates (from myfico.com – see site for current rate estimates):

    FICO score APR May APR Aug payment/mo May payment/mo Aug
    760-850 5.86% 6.27% $2,362 $2,467
    700-759 6.08% 6.49% $2,419 $2,525
    660-699 6.37% 6.77% $2,493 $2,600
    620-659 7.18% 7.58% $2,709 $2,819
    580-619 8.82% 9.32% $3,167 $3,311
    500-579 9.68% 10.31% $3,416 $3,603

    Amounts shown for borrowing $400,000 and rates as of May 7th. For scores above 620, the APRs above assume a mortgage with 1.0 points and 80% Loan-to-Value Ratio. For scores below 620, these APRs assume a mortgage with 0 points and 60 to 80% Loan-to-Value Ratio.

    Frankly I was expecting the rates to show the widely reported expanding of the risk premium (charging increasingly higher rates for riskier borrowers). For example, in May the difference was 382 basis points (9.68% for the lowest FICO range and 5.86% for the highest. However the current difference is just 404 basis points – hardly a big increase. The reason must be that the MyFICO page shows rates for homes with 20% down at the high end of scores and 20-40% down below there.

    Related: 30 Year Fixed Rate Mortgage Rates – Learning About Mortgages

  • Misuse of Statistics – Mania in Financial Markets

    The quantitative schools of investing rely on very high powered mathematics (often drawing on physics and engineering graduate students). They tread on very dangerous ground (often engaging in complex and highly leveraged speculation) and make errors in assumptions about the market conditions upon which the mathematical models they use to invest are based. Fat Tails and Limitations of Normal Distributions describes one common mistake:

    The central reasons why fat tails exist is a result of interdependence during market extremes. People’s decisions are not always fully independent or logical. At extreme market highs, investors become irrationally exuberant. At extreme lows, investors become fearfull and less risk tolerant.

    Stock market data clearly shows that a normal distribution does not provide a good model of the market. Not every system is defined by a normal distribution – it is common for distributions to be close to normal but there is no reason any system need be. Many statistical tools have as an underlying assumption that the system in question is a normal distribution (therefore to use the tools you need to determine if the system can be classified that way – if not some tools can’t be used).

    Crazy as it seems, very smart people continually forget that the markets often experience panics, euphoria, behave in ways that models do not predict, seize up and fail to function… Against the Gods by Peter Bernstein provides a good picture of the chaotic nature of financial market risks. A good book on an example of a mathematical model failure, Long Term Capital Management: When Genius Failed. Another excellent book on financial market chaos is: Manias, Panics, and Crashes: A History of Financial Crises.

    I keep thinking people will learn but so far the faith in numbers seems to outweigh the past examples of overconfident failures.

    Related: Data doesn’t lie but you can be fooled – investment risk – Statistics for Experimenters

  • Real Estate Median Prices Down 1.5% in the Last Year

    Home prices drop for fourth straight quarter. Wow – that sounds bad.

    During the second quarter, the median single-family home price was $223,800, 1.5 percent less than a year ago, according to the National Association of Realtors (NAR). It was the fourth consecutive quarter of price declines. Condo prices rose 1 percent to a median of $226,800.

    Wow, that doesn’t sound bad. For comparison the NASDAQ index was down 1.6% today. In addition, always remember median prices are not as straight forward as it might seem. The mix of housing that sells changes between the periods being compared. Often (though maybe not this time) as the housing speculation subsides the mix of houses shifts as fewer expensive houses are bought which would tend to mean even if prices for identical houses stayed the same the median price (of houses actually sold) would decline.

    Home sales have fallen in many markets, inventories have stretched to a nearly eight-month supply, and new-home builders have been reporting big losses.

    There are real changes taking place in the real estate market but the big changes are increased inventories, increased mortgage defaults and a credit crunch – not declining prices. My prediction of price drops was as small as any almost any I saw over the last few years. And so far, the declines are even less than I thought we would see. The biggest factor for the depth of the pricing declines is going to be how many houses are forced into foreclosure (which is unfortunately possibly going to be high due to adjustable rate mortgages being adjusted up and requiring higher mortgage payments).

    In the short term, the credit crunch is having an impact and that may increase if the jumbo loans (for those with significant down payment and good credit) continue to be hard to finance. But I don’t expect that to be the situation even 3 months from now – of course I could be wrong. The real estate situation (pricing, inventory…), as often is the case, is hugely impacted by the location. Some areas, like Arizona and Florida, are being hardest hit now.

    Related: Real estate articles – Beginning of the End of Housing Bubble? (2004) – Homebuilders’ confidence at 16-year low – mortgage information

  • Housing Inventory Glut

    Housing inventory glut gets fatter

    Zip monitors 18 metro-area markets from all four regions of the country. For the 12 months ended July 31, only Boston and San Diego showed drops. Boston’s inventory fell 5.8 percent and San Diego’s dropped 2.1 percent. The average for the 18 cities was a 19 percent increase in homes on the market
    …
    The wait for tenants may be a long one. It’s much harder to get a loan these days for all but the best borrowers. Borrowers, for the most part, now must put more money down, document their income and assets, have few dings against their credit worthiness and show that they can afford the payments. Those tightened lending restrictions eliminate potential buyers from the market, reducing demand even as more supply hits the listings due to big jumps in foreclosures and builders finishing up projects initiated before the slump took hold.

    What does the current data show about the real estate market overall? Across the country in the last year the median price has actually increased slightly. It looks like the data for the calendar year 2007 will show a decline for about 2%. Some areas have been much harder hit with median prices dropping over 10% (Las Vegas, Florida, Phoenix…). Mortgages any of 1) questionable credit score 2) jumbo loan or to a lessor extent with little money down are becoming hard to come by. Foreclosures are increasing dramatically. Builders are having a great deal of difficulty selling new housing they have built.

    Still the decline in median prices is far from as dramatic as many feel (there have been large changes in the market but it still has not lead to a crash in home values or even a noticeable decline in most places). The increasing supply of houses for sale will put pressure on housing prices to decline. But without a significant continued increase in foreclosures (which is possible but it is still difficult to predict how large an increase we will see) I still do not believe we will see dramatic price declines in most of the country. The possibility (of say declines of over 15% in a year or two) is much higher now than it was in the last couple of years.

    Post from 2004 on the real estate bubble worries then – again prices would have to fall a great deal to fall below the prices in 2004 (possible but not very likely to happen in the coming years). The real estate problems are significant and pose a danger to the economy (they certainly are already decreasing economic growth) however that is much different than a crash in housing prices. And as bad as the credit markets have been and rising foreclosures, increased housing inventory the anticipated crash in prices has still not been seen nationwide – and I stand by my belief we won’t see it. Though I will admit less confidently than at any time so far – I would hedge my bet on this prediction at this point (if I actually had bet any money on that prediction – I have no desire to sell any of my 401k money invested in real estate, my rental property or my house).

  • Credit Crisis

    Well the credit crisis triggered by the fallout from lax mortgage lending is really making waves. It seems we are likely to have some real issues to deal with. The reduction of easy money can have serious consequences to an economy especially one so based on spending beyond what it is producing. I’m still not sure what the overall impact will be but the risks certainly seem to be worth watching.

    The world savings glut has overwhelmed the excessive borrowing done by the federal government and private sector and kept interest rates lower than seemed reasonable. That may finally change – or may not, isn’t economics great :-/

  • Credit Score to Ignore Authorized User History

    Your credit score may change as FICO creators drop authorized users

    the formula for the widely used FICO credit score is about to change. Fair Isaac Corp., creator of the FICO score used by lenders, says it will no longer consider authorized user accounts when factoring a consumer’s score. An authorized user of a credit card is free to use the plastic, but doesn’t have to pay the bill. Parents often make a child an authorized user of their card to give a youngster access to credit. But this has other perks. The child inherits the parents’ credit history. And if it’s a good one, the child receives a high credit score.

    But some Internet-based credit-repair firms have been using this to boost the credit scores of strangers with poor credit. The firms pay a person with an excellent credit score to add someone with a rocky record as an authorized user on a card for a few months. The authorized user doesn’t ever use the plastic. Instead, he or she gets the benefit of the account owner’s credit history, which can raise a weak score by a couple of hundred points.
    …
    Worse for some, the change will mean no FICO score at all. Fair Isaac estimates 1.5 million to 3 million consumers will no longer have enough information in their credit report to be able to produce a FICO score. Among those most likely affected are young adults who have been added to their parents’ accounts.

    Related: Example of Mortgage Payments Depending on Credit Score – Your FICO credit score explained

  • Too Much Stuff

    Buy less stuff. Save more. Not a complicated plan, along the lines of: Eat food. Not too much. Mostly plants. Paul Graham posts excellent essays online. His latest is another good one – Stuff:

    Companies that sell stuff have spent huge sums training us to think stuff is still valuable. But it would be closer to the truth to treat stuff as worthless. In fact, worse than worthless, because once you’ve accumulated a certain amount of stuff, it starts to own you rather than the other way around.
    …
    In industrialized countries the same thing happened with food in the middle of the twentieth century. As food got cheaper (or we got richer; they’re indistinguishable), eating too much started to be a bigger danger than eating too little. We’ve now reached that point with stuff. For most people, rich or poor, stuff has become a burden.

    Related: Saving for Retirement – Frugality Versus Better Returns – Real Free Credit Report – Our Policy is to Stick Our Heads in the Sand

  • Is Google Overpriced?

    Don’t go gaga over Google by Geoff Colvin, Fortune senior editor-at-large:

    It has created more investor wealth in less time than any company in history. So investors, repeat after me: All hail, Google! But don’t put it in the wealth-creation pantheon quite yet. And please don’t buy it at today’s price.
    …
    we need to remember that the ringing superlatives are based on a stock price that’s nuts. Google is a terrific company that may one day deserve to sit beside GE, Exxon and Microsoft. But not yet.

    He is welcome to his opinion. Lets look at some previous opinions, August 2004 Wall Street Week transcript:

    COLVIN: There’s another question. We now have a company that people have to decide whether they want to invest in. $23 billion is a high valuation for a search engine, right? I mean…
    KIRKPATRICK: For anything.
    COLVIN: For anything. And, you know, we can remember when AltaVista was everybody’s favorite search engine. Google came along, better product, superior, took away the market, but who’s to say the same thing won’t happen to them?
    SCHLOSSER: Well, they are creative guys, though. I mean I have a lot of faith that they’ll come up with some new ideas down the road that we’ll be able to watch for years to come.
    COLVIN: What do you think, David? Is this valuation justified?
    KIRKPATRICK: Well, I would never say that. I think any kind of valuation at this sort of level is very, very hopeful about future opportunity.

    It is true Google is priced to perform well today (and if they fail to do so the price will go down). And I don’t think it is as good a buy today as it was at $185 (I foolishly didn’t buy at IPO). I did buy more earlier this year, which I am happy to put away for a decade and see where it is then. It is great if you can buy a good stock cheaply but often you are better paying more for a very well managed company than buying cheap companies (by PE, cash flow or EVA or whatever measure you want to use). When I started the 10 stocks for 10 years portfolio in 2005 I put 12% in Google which has increased 134% (along with 12% in Toyota, which is up 67%, and Dell which is down 15%). Google is actually the 3rd best performer as of today (Amazon, up 136%, moved ahead and PetroChina is up 140%). I don’t think Google investors are betting on impossible growth, but time will tell. And the internet makes it easy to see what people predicted previously so we can all see who was right in 5 or 10 years.

    I do think at these prices Google is a riskier investment (with lower likely returns) than is was at lower levels (Amazon too). While this may seem obvious, it really is not as obvious as it may seem. If Google’s prospects had improved more than the price increased then at a higher price I might see it as a safer, or possibly better investment… This is what happened when I first bought Google at maybe $190 – after not buying at the IPO. Basically I do not believe Google’s prospects have not increased as much as the stock price in the last 2 years. Certainly I could understand passing up investing in Google today (if so, I would keep a watch out and consider buying if it falls…) but I am perfectly happy to keep my holdings.

    Read this article from Fortune (not by Colvin) in 2004, GOOGLE @ $165 Are these guys for real? some quotes:
    (more…)

  • Another Great Quarter for Amazon

    I have mentioned I like the way Amazon, and Jeff Bezos, have been managing in several posts. Recently Amazon has added very strong financial results to that portfolio of things they do well. Amazon earnings announcement:

    Net sales increased 35% to $2.89 billion in the second quarter, compared with $2.14 billion in second quarter 2006. Excluding the $46 million favorable impact from year-over-year changes in foreign exchange rates throughout the quarter, net sales grew 33% compared with second quarter 2006.

    Operating income increased 149% to $116 million in the second quarter, compared with $47 million in second quarter 2006. Net income increased 257% to $78 million in the second quarter, or $0.19 per diluted share, compared with net income of $22 million, or $0.05 per diluted share in second quarter 2006.

    Pretty impressive. It seems Amazon might be able to begin delivering strong current financial performance (they have done so at least twice, and maybe longer depending on how you look at it…) and continue to build and innovate for the future. That is when a company really sets itself apart from the crowd. Previously, from the investing perspective, the argument was largely based on the belief that the steps taken today were building for the future (a fine thing, but risky – without the evidence of success actually making real profit it is often easy to make a good case for why the future will be good). In an investment it is more comforting when current earning provide some evidence the profits predicted in the future have some basis in reality.

    Since the beginning of April Amazon’s share price has gone from $40 a share to $70. And based on the after hours trades today it is going to be in the $80s tomorrow (though after hours trades can often be misleading – there is some more confidence based on the large volume of hour trades in Amazon, but still…). I must admit this price does seem like it might be getting a bit ahead of itself but Amazon is making an impressive case for strong future performance.

    Related: Amazon Innovation – 10 stocks for 10 years (April 2005) – 12 Stocks for 10 Years Update (June 2007) – Very Good Amazon Earnings – Bezos on Lean Thinking – Is Amazon a Bargain?

  • How Walkable is Your Prospective Neighborhood

    Walking to accomplish tasks (getting food, going to work, shopping, going to play basketball) provides a better quality of life than having to drive (getting stuck in traffic jams…) and saves money and protects the environment. Walk Score is a cool web site that lets you calculate a walkability score. I would imagine the better the walkability score the better for the prospects of a real estate investment. You still have to determine if the current price already reflects the long term benefits to quality of life (which are then represented in increased prices) – I think often they will not be providing an investing opportunity. My guess is that real estate would increase above the market if you invested in areas that show walkability score increases during your ownership.

    Related: Urban Planning and Real Estate Investing – Real Estate articles – 30 year fixed Mortgage Rates – Real estate blog posts