The 4cs Of Borrowing Money

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Real Estate 2006:

BY CHARLES SCUTT

The Crash That Wasn’t If there’s been one outstanding characteristic regarding real estate in 2006, it’s been the inability to recognize good fortune. Despite the endless claims in 2006 of crashes, busts and slumps, real estate has been a terrific investment for most people. Real estate is a commodity. Like pork bellies and gas futures, prices rise and fall. It’s simply not believable that real estate values always rise in all local markets. Given that real estate values can and do fall, it follows that after years of steady appreciation real estate prices were destined to stall. However, the important point is that if you bought a few years ago the odds are overwhelming that you’re ahead. According to the National Association of Realtors, the typical existing home was worth $220,000 in September 2006.You can look at this number and say, aha, that’s down 2.2 percent from a year earlier. But how many people sell in a year? Let’s make a more realistic comparison: In September 2002, the typical home sold for $159,000. In just four years, the typical home appreciated $61,000. How many of us have other investments that have done as well? How many of us have other investments that also provide shelter? Interest rates in 2006 eased the real estate slowdown. Freddie Mac figures show that typical rates for 30-year, fixed-rate loans started at 6.21 percent in January, reached 6.79 percent in July and by October were down to 6.37 percent. The interest levels seen in 2006 did not match the record lows of 2003 (remember 5.21 percent?), but we certainly enjoyed bargain-basement financing. In 2000, for example, you likely paid 8 percent or more for a new mortgage. Or, in an extreme example, it’s useful to remember that in 1981, rates for new mortgages typically topped 16.5 percent. But what of the future? Some points to consider: • Much discussion regarding real estate concerns national pricing trends – however, you want to know about trends in your particular community.What happens locally is what matters to you. For this reason, it’s important to read the local newspaper daily to see where development is heading, to watch for population increases and to track job growth. See ASK OUR BROKER, Page 2

HOW 4 C’S MAKE A GRADE-A BORROWER CTW Features

long-range community plans.” Many metro areas are pursuing sizable facelifts.Those facelifts don’t come out of nowhere. Read papers and check online through city sites. Contact local chambers of commerce, which tend to know long-range plans. Libraries are an often-overlooked resource nowadays, but librarians know quite a bit about local government, local ordinances and development.The information is readily available and an investor who gets in on the front end can do quite well. The city of Huntington Beach, Calif., is talking about closing off

DOCTORS RECOMMEND the two E’s: exercise and eating right. Teachers stress the three R’s: reading, writing and ’rithmetic. And mortgage lenders emphasize the four C’s: capacity, capital, collateral and credit. As simple as it sounds, this quartet of factors essentially is what banks and lenders use to evaluate a mortgage loan candidate. How a prospective borrower stacks up in these four categories will determine whether the applicant is a good risk or a losing proposition. “It’s important for borrowers to understand the four C’s in order to best prepare themselves to obtain a mortgage loan,” says Steve Habetz, president,Threshold Mortgage, Westport, Conn.“Having strengths in all four areas ensures a consumer’s ability to qualify for the best financing available for the type of mortgage they wish to obtain.” Often first on a lender’s mind is credit, which is a measurement of the confidence in the loan applicant’s ability and willingness to repay a debt. Using as a barometer the borrower’s credit history and credit score – as graded individually by the three major national credit unions, Equifax, Experian and Trans Union – the quantity and quality of the person’s credit obligations needs to be carefully scrutinized by the lender.This is done not only to forecast how the person will manage his credit duties in the future but to determine the monthly amount of other, nonhousing related debt he or she carries. Scores over 750 considered to be outstanding and scores under 620 judged as highly risky. To Sandy Shaud, host and executive producer of Real Estate Investment TV – an Internet and soon-to-be nationally televised show based in Los Angeles – credit is the most

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Busy bodies: Areas where shops and restaurants are popping up are areas where people enjoy themselves and, ideally, want to live.Tapping into one of these hot spots before it mushrooms could turn into a profitable investment.

Hot Properties Just as Plentiful in Cool Market BY PAUL ROGERS CTW Features

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hile certain regions, cities and neighborhoods still are enjoying strong home appreciation, most agree that today’s real estate market in general has, at best, plateaued.That’s not necessarily bad news – particularly for the novice or small-scale investor. In fact, many say now might be an excellent time to add property to a portfolio or start a new one – provided, of course, that it’s the right property. That begs the age-old real estate question:What is the right property? How do you identify those “hot” areas when they are

just lukewarm? Well, in a flat or down market, those questions can be easier to answer and those properties easier to acquire than in the blazing-hot real estate market of recent years. The key to finding a good real estate investment is knowing the neighborhood.That deal property – the one poised to return the most profit – may be right in your own backyard. “Look at areas you’re familiar with,” says Mark Nash, a Chicagobased real estate broker and author of “1001 Tips for Buying and Selling a Home” (SouthWestern Educational, 2005).“You know the growth possibilities, employment opportunities and

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BORROWER Lenders look for reponsible financial behavior CONTINUED FROM PAGE 1 important of the four criteria lenders review. “Today, you can get 100-percent financing even on investment properties if you have a credit score over 680,” she says.“Lenders will throw money at borrowers with good credit.” Often, a borrower “will not have a clue about their credit score until they make application with a lender,” says Joseph Ventura, manager,William Tell Financial Services, Latham, N.Y.“Borrowers should check their credit reports before making application with a lender to uncover any obstacles to an acceptable credit score.” “A credit score is clearly the fuel for the mortgage underwriting engine,” says Logan D. Payne, CEO, Creative Mortgage Partners Corp., Orlando, Fla.“You can make changes to one of the other C’s and they will not have as much of an effect as movement in the borrower’s credit score can.” Ask Adam Brown, vice president of Topdot Mortgage, Jericho, N.Y., what he believes lenders weigh as most important, however, and he’ll tell you it’s capacity: the borrower’s ability to repay a debt, which is based on his work history and income. Banks and mortgage companies want to be sure that an applicant has a stable earning source that is likely to continue and a financial lifestyle that demon-

EXPECTATIONS Risk tied to desired length of ownership CONTINUED FROM PAGE 1 traffic on the main street in its downtown area and turning it into a pedestrian boulevard. “They’ve been talking about it for a long time and it will eventually happen.And when it does, the closer to that you are, the better off you are,” says Steven Thomas, a RE/MAX broker/owner in Orange County, Calif. Some of the evidence is directly in front of your face. “Look at demographics, where small boutiques, where great restaurants, where interesting shops are popping up.Typically those areas mushroom a little bit and people want to live where they’re going to have a good time,” says Ellen Bitton, chief executive officer, Park Avenue Mortgage Group, New York.. Tribeca is a trendy Manhattan

strates responsibility. Typically, the benchmark that lenders follow is that principal, interest, taxes and insurance should not surpass 28 percent of the borrower’s gross monthly income, which is comprised of any salaried or hourly wages plus any extra income from overtime, part-time jobs, pensions, dividends or other sources. Also, PITI combined with regular monthly debts like an auto loan or credit card payment shouldn’t exceed 40 percent of gross monthly income, says Payne. Shaud says that collateral can be an equally important C. Collateral is defined as the value of any assets a borrower pledges as security for a loan – usually consisting of the down payment plus the value of the property being financed.The borrower signs documents at closing giving the lender a lien against the bought property, enabling the lender the take possession of the collateral (property) through foreclosure if mortgage payments aren’t made as written in the contract. The lender must determine the property’s value to ensure that the residence is worth as much as the amount being lent. In general, the loan amount usually shouldn’t surpass 95 percent of the appraised property value or 95 percent of the home’s sale price, whichever is less.This is where the evaluation of a lenderrequired professional appraiser comes in. “The final piece of the puzzle is capital,” says Brown, which consists of a borrower’s total property and cash assets available for securing a mortgage loan and for paying off debt.“Lenders want to be sure that the client has the money needed to make their pay-

neighborhood, called home by high-profile artists and film people. But back in the late 1980s, it was considered a frontier. Still, it was less congested than other areas of Manhattan and home shoppers could get more space for the dollar.A couple good restaurants set up shop, some big name celebrities moved in and upgraded spaces. “Then they built a couple great schools in the neighborhood, and it was a foregone conclusion,” Bitton says.“Take your hint from the experts. If Donald Trump moves into an area, chances are the area already is there or about to happen. Follow their lead, just like you would listen to stock market gurus for stock advice. Listen and read and become as educated as possible.” Look to the fringe areas of established neighborhoods, as well as those that back up to severe locations, such as power lines, major streets and highways. Both are the fastest to lose their value in a down market but rebound best in a hot market.

ments.When analyzing income, banks want to see two years of consistent work history, as well as money in checking and savings accounts, stocks, mutual funds and other sources.These available funds can help to lower the candidate’s risk level.” Although the amount of funds necessary to close a real estate transaction will vary, the minimum capital that lender’s expect borrowers to have is approximately 6 to 8 percent of the sales price. Capital becomes more important as the size of the purchase increases, says Habetz. Ultimately,“the most important factor to a lender is determined by the lender themselves and the underwriting practices they follow,” says Roland Chupik, executive director of Neighborhood Housing Service of Oklahoma City.“For example, one lender may put a higher value on high credit scores for qualifying a borrower while another borrower may relax that factor. Certain lending programs in a community may give more flexibility to a lender regarding credit scores and capacity.And down payment assistance programs usually sponsored by a governmental entity either directly or through a nonprofit organization may increase a borrower’s capacity to purchase a home.” Chupik believes there is a fifth C in the process – the one he calls common sense. “Often, people who desire to purchase a home emotionally enter the process only to find they cannot afford the home. Borrowers must be realistic about the home they can afford and must investigate their ability first.”

On the other side of the coin are those areas that you may not even have heard of. Thomas points to one area north of Mission Viejo, Calif., on other side of the reservoir with limited access.“Really tucked,” he says.A 3,000-square-foot singlefamily residence in Mission Viejo might now run $750,000, but the same home in that tucked neighborhood would price out at $675,000. Still, when the market turns back up, the tucked property will be right there at $750,000. In your research, watch for negatives, as well as positives. Make sure there isn’t a proposed landfill or new four-lane highway on the drawing board.Watch for industrially zoned property. Even if no industry is there at present, as long as it’s zoned for industrial, it could legally happen.And watch out for areas that are being saturated with new housing. All is a matter of risk tolerance. Even if signs point to yes, there are no guarantees the investment will immediately make money. “If you have low risk toler-

© CTW Features

ance, you are better off buying in an average neighborhood and taking average appreciation. If you are more risk tolerant, you can go into edgier neighborhoods that look like they have a bigger upside,” says Nash. But there’s no telling when that upside might actually go up. The Rogers Park area of Chicago has been “on the cusp of popping for five years and can’t seem to get there,” says Nash.“And it’s not going to happen in 2007 or 2008 either.As a generalization nationally, I don’t think 2007 is the year to take real estate risks.The market is still correcting and what we don’t know yet is whether there are enough buyers to absorb the pool of inventory we have.” Of course, all is tempered by how long you plan to hold the property.The longer you plan, the less risky the buy. “I really have not seen people who held onto property 10 years lose money,” says Bitton.“A five- to 10-year horizon is sufficient to have appreciation.”

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• In 2006, we saw a significant new-construction slowdown. By reducing new-home construction, supply is reduced – thus helping to maintain home prices. • It’s difficult to believe that interest rates in 2006 remained so low – I thought they would surely top 7 percent, and 7 percent hardly is steep. It’s equally difficult to believe that rates will remain as low in 2007. My reasoning? Five straight years of huge federal deficits that amount to more than $1.5 trillion plus massive balance-of-trade imbalances: $792 billion in 2005 and $432 billion in just the first six months of 2006. Deficits and trade imbalances should lead to higher interest rates because they mean more competition for investor funds, but somehow that wasn’t the case in 2006. It seems unlikely that we will be so fortunate in 2007. And so, again, I expect interest rates to top 7 percent. If rates do not go up, you can at least expect more than a few economics textbooks will be rewritten. There are other factors, pro and con, that also will be at work in 2007. • The population reached 300 million in 2006 and continues to grow. More people equals more demand for housing. • The employment picture nationwide remains positive, but there are big differences in local communities. Shutdowns in the auto industry, as one example, have battered many state and local real estate markets. While a growing population (more demand) and reduced homebuilding (less supply) favor price stability if not higher home prices, higher interest rates could quell demand and thus slow home-price growth. Competing market forces do not all point in one direction, a reality that may suggest moderate pricing movements up or down. There is, however, a new and unknown factor in the marketplace: Since 2001, many homes have been financed with interest-only and option adjustable-rate mortgages – so-called “non-traditional” forms of financing that permit low initial monthly costs. But what will happen when “start” rates end and required monthly payments increase and sometimes double? One possible and logical result would be a cascade of owners selling homes at discount prices because they can no longer afford monthly payments. Such fire sales would push down home values, generally, and few local markets would be immune. That’s scary stuff – and reason to finance and refinance with fixed-rate loans. © CTW Features Need real estate advice? Peter G. Miller, author of “The Common-Sense Mortgage,” would love to hear from you. Send your questions to [email protected].