Knowledge is Power

May 14, 2010

Finance

Know Your Budget

Know Your Budget

The other day I was reading an interesting article regarding a high correlation between mathematical/financial education and default rates on mortgages. Basically, the data in the article showed that a greater portion of delinquencies and foreclosures carried today are associated with borrowers who lacked the sufficient knowledge to fully understand the basic terms of credit to which they were agreeing and how that affects their total financial picture. I found this especially interesting as we all sift through the ashes of the last housing bubble to see what went wrong. To fully clarify, I do not mean who is to blame as I feel that culpability is shared in some part amongst all of the players and stakeholders. Rather, I think that this is what is sometimes called a learning moment regarding consumer responsibility when seeking a mortgage loan or any credit for that matter.

Know you personal budget

I am always amazed when somebody comes into my office and asks me how much they can afford. This question, which incidentally spans all socioeconomic groups, communicates immediately that a client does not maintain a personal budget. They inherently do not know how much money it takes to maintain their current standard of living and how much flex they have in this calculation when factoring in a new purchase to continue to live this way. That is not to say that I cannot run their numbers to see whether or not they meet the guidelines of a particular program, but this is not analyzed in the context of their overall personal budget. While I personally make it a practice to show them how their disposable income will look once in the loan, it is the client’s responsibility to look at the numbers to make sure that they support current lifestyle and spending patterns and to act accordingly.

Understanding your payment

While there are a myriad of available programs available in the mortgage marketplace, they all boil down to the terms under which you are borrowing money from a creditor. In short, you are borrowing a specific amount of money over a predetermined period of time at an agreed interest rate. This equates to a monthly payment to you that needs to be serviced every month. Granted some very exotic programs crept into the market place toward the end of the bubble, but none of these re-wrote the book on how a mortgage payment is calculated. There are even tools to calculate the payments available on the Internet to eliminate the need to fully understand the math behind the concept. So, if you cannot calculate the payment yourself, you need to consider whether or not you have the current knowledge that you need to commit to the debt. If not, you need to send up the signal flag and get the help you need to understand this before you sign on the dotted line.

Understand the Terms

As I mentioned earlier, there are a lot of programs available for the purchase or refinance of a home. For the most part, they boil down to fixed or adjustable options. If it is a fixed rate, you have secured a rate for the entire term of the loan and it does not change. If it is adjustable rate, the rate and payment change at some point in the loan term based on market conditions. Yes, it is that simple. To make things even simpler, these terms are clearly articulated on all of the documents that you see during the loan process. It is your responsibility to yourself to both read and fully understand the specifics. If you cannot mentally check both of these boxes than you need to stop the process immediately and take the time to do both. After all, you own this loan once you sign on the dotted line.

Choosing the Right Lender

While this does not seem important, I would propose that it is the most important step of all. You will likely have gaps in the aforementioned steps. Almost everyone does, but the right lender looks at it as his or her personal responsibility to make sure that the gaps are filled. I actually think back to the height of the bubble when credit was easier to obtain and the panoply of programs was significantly broader that it is now. Even then I took the time to ensure that my clients fully understood their options. Most chose to listen to my advice and integrate it into their decision-making process. Others, succumbing to tunnel vision on obtaining the home, chose to ignore or disregard certain material aspects of their own situation and how they would be affected. For me, this sometimes meant losing business as my honesty was eclipsed by the lure of low rates regardless of the terms offered by a competitor. Are the lenders who miscommunicated or misrepresented a certain loan program to blame? The answer is unequivocally yes. Are the borrowers also worthy of significant constructive criticism for failing to fulfill the responsibility of choosing a reputable lender? I would say so.

In the end, you need to look at a home purchase, or any financial decision, in terms of how it impacts you. Like the ripples from a stone thrown into a pond, the effects of assuming a mortgage can influence your quality of life and financial future. Providers of credit and financial services will and do assist you in evaluating your choices, but only you hold the yeah/nay power to move forward. Because of this, it is your responsibility and duty to yourself and your family to ensure that there are no knowledge gaps before you sign on the dotted line.

We would like to thank Weddingssc1 for kindly sharing today’s photo via the Creative Commons’ License.
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About Doug Katz

As the Senior Mortgage Banker and Sales Manager for Chicago Bancorp, Doug not only originates loans for his personal business, but also oversees affiliations with banks and other financial institutions that depend on Chicago Bancorp to meet their client’s lending needs. In this role, Doug directs the day-to-day mortgage sales operations of over 25 branches in a multitude of Chicagoland’s diverse communities. He brings to these relationships a wealth of industry experience and a dedication to an exceptional client experience that has established Chicago Bancorp as Chicago’s pre-eminent mortgage solution providers. Prior to joining Chicago Bancorp, Doug attended and graduated from West Point. Upon graduation, he was commissioned as an officer in the United States Army Artillery, where served 5 years in numerous roles and in various deployments include service in Kuwait. In addition to his Bachelor’s Degree from West Point, Doug holds an M.B.A. from Loyola University Chicago, where he was also inducted into the Beta Gamma Sigma Honor Society. He also served as President for the West Point Society of Chicago from 2003 to 2005 and still serves on the Board of Directors. When not working, he spends his time with his wife and three children in their hometown of Oak Park, as well as pursuing his passions for fitness, cooking and the banjo. Doug can be reached by phone at 312.738.6079, by email at doug@chicagobancorp.com, on his own blogs, BankerDoug.com and Vet Money Matters. He's also on LinkedIn.

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4 Responses to “Knowledge is Power”

  1. Bill Fulton Says:

    Great analysis. I have a stock pitch for clients that don’t understand the ratios. I give it to them then pass them to my mortgage broker for the prequalification process.

    How was you market last month? In April, Orlando home sales were up 32% over April 09. However the median price was 11% below the median in 2009. Bank Owned and Short Sales still make up 2/3 of the transactions with bank owned properties being almost 50% of the total. Inventory is now at a 6.55 month supply with new bank owned properties metering into the inventory in at a managable rate.

  2. Doug Katz Says:

    The market out here is OK. Chicago is interesting in that each suburb and neighborhood varies greatly. With this variance comes significant differences in the health of the real estate market. The big challenge is financing condos. We are getting a lot of them done, but the added complexity definitely gives me pause.

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