Booming Housing Market Was Really a House of Cards:
Part 2
You can’t expect the one selling you a product to
watch out for your best interests
By Jeffrey D. Voudrie, CFP
April
4, 2008 - Last week, I talked about how the current credit crises
evolved. This crisis is the result of mistakes made by the homeowner,
the mortgage company, the investment banks and the rating agencies. This
week, you’ll see what caused the House of Cards to fall and will learn
how this example can keep you from making a financial mistake.
Leverage was used at each stage of the
mortgage-chain. Leverage is when money is borrowed so that additional
investments can be made. The idea is that more can be earned on the
investment than has to be paid in interest on the loan.
So the homeowner borrows the full value of the
home, the investment banks borrow money so they can buy more loans, etc.
While leverage can increase returns, it also exacerbates a decline.
For example, a popular concept these days is to
borrow the equity from your home and invest it in life insurance (one
that I don’t agree with). Perhaps both spouses work and their income
easily covers the additional mortgage payment. The couple only sees the
potential profit and doesn’t realize if things don’t work out, this
transaction can be very costly to unwind.
Suppose one spouse loses their job and their income
falls short of covering the mortgage payment. Or maybe their mortgage
payment increases because of interest rates. Unless the spouse can find
another job, the couple will be faced with having to sell their home
quickly to pay back the mortgage company.
First part of a simplified explanation of the credit
crisis that has overtaken our economy
March 31, 2008 - The current credit crisis has
impacted multiple sectors of our financial economy. Home foreclosures
are on the rise. Credit-worthy consumers struggle to secure mortgages.
Investment banks are brought to their knees. Foreign and domestic stock
markets experience gut-wrenching volatility. The Federal Reserve is
forced to take historical steps to maintain liquidity. And the list goes
on.
Read more...
If there are lots of other people in the situation,
all trying to sell their homes at the same time, the value of a home is
going to drop quickly.
Taking this example a step further, if home prices
in general have declined 20%, then those who had 20% equity in their
home suddenly have none. Now their home is only worth what they owe. Or
they may have a home equity line of credit. The bank is going to reduce
the line of credit based on the decreased amount of equity.
That’s basically what has occurred on a national
scale at every point in the mortgage-chain. If a portfolio of mortgages
is used as collateral and it’s suddenly worth 50% less, the lender is
going to want their money.
What should we learn from this? First, examine why
so many homes are in foreclosure. Is it because the borrower wasn’t
informed about the details of the loan? No, the bank or mortgage company
provided lots of fine print for homeowners to sign, explaining every
aspect of their loans, including how interest rates would increase
payments in the future.
Did banks or mortgage companies illegally provide
mortgages to consumers who weren’t qualified? No, not really. Obviously,
the mortgage lenders wanted to sell as many mortgages as possible
because that’s how they made money. It wasn’t their job to ‘protect’ the
borrower.
It’s the same in the world of investing. You can’t
expect the one selling you a product like a mutual fund or annuity to be
the one to watch out for your best interests. As a consumer, it is your
responsibility to do the research, read the fine print and thoroughly
understand any financial contract you sign.
A financial advisor isn’t going to say to you,
“Hey, this might not be the best investment for you. Your money is going
to be locked up for 15 years and the only way you can tap it is by
paying a big penalty. Besides, you can earn even more using a balanced
portfolio of quality investments.”
Believe it or not, a commission-based broker or
agent is NOT legally obligated to do what is in your best interest. They
only have to offer investments that are ‘suitable.’ ● They don’t have
to make sure you understand the fine print you sign. ● They don’t have
to go over all the future consequences of your financial decisions. ● They don’t have
to sort through all your investment options and find the one that fits
you perfectly.
That’s not their job!
Don’t let fear or greed cause you to defy common
sense when it comes to investing. Do independent research - read and
carefully parse the fine print and if you can’t understand it then you
shouldn’t buy the investment.
Don’t let a smooth-talking advisor cause you to
skip any of these important steps.
If you have a specific question or would like more
information, give me a call toll-free at 1-877-827-1463 or you can also reach me by email at
jeff@guardingyourwealth.com.
I will answer your financial question FREE.
About Guarding Your Wealth:
“Guarding Your Wealth” is a
nationally syndicated weekly personal finance column written by Jeffrey
D. Voudrie, CFP. Mr. Voudrie is the President of Legacy Planning Group,
a private wealth management firm that employs sophisticated proprietary
strategies designed to protect and grow its clients' investments. Visit his website,
www.guardingyourwealth.com to read past articles under the Guarding
Your Wealth Article Archive that may not have appeared in
SeniorJournal.com.
Guarding Your Wealth for Seniors, on
SeniorJournal.com, is
a collection of columns by Voudrie that deal with issues of particular
interest to senior citizens.
Click here
for all columns.
In addition to being a nationally
syndicated columnist and Certified Financial Planning Practitioner, Mr.
Voudrie provides personal, private money management services to select
private clients
nationwide.
Looking for an energetic expert who
is passionate about financial and wealth management? Mr. Voudrie is an
excellent speaker who will excite and inspire your audience. Mr. Voudrie
is available for a limited number of speaking engagements, television
appearances and radio talk shows. For bookings, email
jeff@guardingyourwealth.com.
Keep up with the latest news for senior citizens, baby
boomers
April
4, 2008 - Last week, I talked about how the current credit crises
evolved. This crisis is the result of mistakes made by the homeowner,
the mortgage company, the investment banks and the rating agencies. This
week, you’ll see what caused the House of Cards to fall and will learn
how this example can keep you from making a financial mistake.