New Fico Credit Score

An article in the Wall Street Journal caught my attention on the train in to work today. I'd heard the credit bureaus were coming up with a new credit score calculation called "FICO 08", but I wasn't sure when it was coming into play. According to the article, TransUnion is going to begin offering the score today, but it could be months or years before it comes into common use and consumers can find out their own scores.

Supposedly the new methodology will make credit scores more accurate at predicting defaults, which will allow lenders such as mortgage companies to more properly price loans to consumers.

My FICO score is very high (I don't think much has changed since the last time I looked at it), but the problem I've run into being in my late 20s is that my credit history is relatively short, which worked against my credit score. From what I've read in the article, FICO 08 is supposed to correct this somewhat:

"The score, which will still range from 300 to 850 -- the higher, the better --
is fine-tuned to do a deeper analysis of subprime borrowers or those with "thin"
or young credit histories, according to Fair Isaac. More consumers with accounts
in good standing should also see their scores increase slightly, says Tom Quinn,
vice president of global scoring solutions at Fair Isaac. Overall, Fair Isaac
predicts FICO 08 will improve the accuracy of lending decisions by as much as
15%."

Not life-changing news by any stretch of the imagination, but as someone who is potentially in the market to buy a home, it piqued my interest.

New Jersey Housing Prices Fall

I came across a pretty interesting blog recently- http://www.njrereport.com/. It publishes news stories and examples of New Jersey homes being offered well below previous purchase or asking prices (which it refers to as "comp killers" because when they sell for lower prices, they serve as comparisons ("comps") for other homes being sold nearby and therefore drive down prices in an area.) Perhaps the most interesting part of the site is the comments, so be sure to check out the discussions when you're reading posts.

I think the blog is written by a real estate broker in NJ who very correctly called a top in the NJ real estate market in 2005.

It's an interesting read if you're following the real estate market, or if you're in the market to buy a house in NJ (or the northeast in general).

So where am I in the process? I'm still on the sidelines for a first home. I got married in 2005, at or around the top of a real estate bubble in one of the most overpriced areas in the country. I realized it would have been impossible for me to responsibly buy a home at that time, even though people with significantly lower incomes and down payments were doing so all around me. It was very easy to look at the numbers and see that I couldn't afford jack at that time. I posted about this a few times in the past, and I'm still waiting for prices to fall further. The news has been getting more and more encouraging, but prices are still ridiculous. I'm hoping real estate price declines continue, I'm hoping nobody bails out the people who took on mortgages they couldn't afford, and I'm continuing to build my down payment savings in the meantime. I hope to buy sometime in the next couple of years. I'm not worried about "missing a bottom" because I know once real estate prices fall, they don't generally bounce right back up, they tend to stagnate for a while.

How am I going to know when the time is right to buy? First of all, I'm definitely not going to try to pick a bottom. What I am going to do is continue to update my calculations of what my wife and I can afford on one salary, and when something looks both affordable and attractive to me, I'm going to go for it. I'm not too worried because my rent is pretty cheap for the time being. Right now, prices in general are still pretty ridiculous. I either need to save a lot more money, or see prices come down a lot before I really focus on the home buying process.

What Should The Average House Cost?

I've been trying to talk about my view that home prices need to fall further, but seekingalpha.com did it better than I could. Check out this discussion of home prices. They argue that the price of the average home should be somewhere around 3.2 times median household income, where it has been for the past 30-40 years. Put in today's terms, they argue that the median home price should be 3.2 times the estimated 2008 median annual household income of $52,134, or $166,829. This represents a 40% drop from the current levels just above $200,000.

I agree with that math.

Of course, you could make the argument that home prices don't necessarily need to have a correlation with household income, or that the ratio of around 3 times income no longer applies. However, I think you'd be kidding yourself.

How Many Ounces of Gold Does It Take to Buy the Average House?

Investmenttools.com has some pretty interesting housing price graphs. One of them shows how many ounces of gold it has taken to buy the average house over the years.

Another shows how many shares of the Dow Jones Industrial Average it takes to buy the average house. It's interesting to note that chart looks very different from how many US dollars it takes to buy the average house. Back around 1980, it looks like it would have taken about 110 shares of the DJIA to buy the average house, whereas now it is more like 22 shares. This shows how much stock price increases have outpaced housing price increases over the past 25 years or so.

As a side note- amid all of the doom and gloom, the index fund that 60% of my 401(k) contributions are going into has returned 8.7% this year. It seems like the sky was falling for some reason or another every week this year (primarily because of subprime headlines). All of the resets, the foreclosures, the dollar falling etc... and yet a stock market index fund still quite handily beat returns on most other financial products such as CDs and savings accounts. Thanks to my modest allocation to international and emerging markets funds (up about 16% and 50%, respectively), my overall 401(k) portfolio is up 11.3% on the year. Not too shabby.

Plan to Bail Out Subprime Mortgage Holders

You might have read about plans to prevent certain subprime mortgage rates from "resetting" to higher rates in the next few years in the papers lately. If you have, you fall into one of two camps. The first camp is people who have subprime loans and are terrified of the reset that's coming up because it will push your mortgage payments up to unaffordable levels. If you're in the second camp, you're angry that idiots who took out bigger mortgages than they could afford to buy homes they couldn't afford will be bailed out, preventing them from being forced to sell and allowing home prices to come back down to more reasonable levels.

If you've read my prior posts about buying a house, you probably know that I'm firmly in the second camp. As I talked about in "The Subprime Mortgage Default Opportunity," I thought these painful resets would force people to sell and help the housing market to correct.

Don't get me wrong, I'm in favor of helping the needy. People whose homes were destroyed by a natural disaster deserve to be bailed out. People in other unfortunate circumstances deserve to be bailed out. However, people who bought houses they couldn't afford do not deserve to be bailed out.

So where are we in the bubble/bust cycle? I've been following some interesting posts in a blog called "Misha's Global Economic Trends Analysis" and I think he has a good illustration where he overlays the US housing market on a graph of Japan land prices during that country's bubble and bust from 1980-2004. According to that chart (and most experts), we're in the early stages of a decline. I don't know for sure what to believe, but I sure hope it falls a lot further so that honest, hardworking people can afford to buy a decent house to live in.

By the way, my current favorite source for housing market related news is Patrick.net's Housing Crash News. Its updated daily with stories around the web about the overinflated housing market in the United States.

Double Digit Housing Price Declines

Seems like a lot of people have finally decided that it is possible for home prices to decline. Moody's economy.com says it sees a national average decline of 7.7%, as some areas see declines in the double-digit percentage range. Unfortunately, New York City is not one of those areas.

Glad my down payment savings are in cash/Some current investment ideas

The recent market turbulence has made me even happier that I keep the bulk of my down payment savings in an ING direct account. I currently have about $128,000 in deposits at ING Direct, the vast majority of which is in my Electric Orange account earning a 5.30% APY. Sure, this isn't a fantastic return, but this is money I am going to need within the next couple of years in order to make a down payment on a house, pay for moving expenses, new furniture, etc... When the market slides, I can be glad that no matter what, when I went to my account balance on August 11 (this morning), I would have about $180 in interest accrued to me. If I don't add to my balance, it goes up by about $500 a month due to interest earnings.

Of course, I do have a big chunk of my networth in the market, but this is mainly my retirement savings, which I think will do better in stocks over the next 30 years than it would do in a savings account or in fixed income instruments.

My thoughts on the recent market turmoil? I am not very worried. Markets fluctuate, sometimes dramatically. Don't turn into a lemming and follow the market off of the cliff (if that's where it ends up going). If you invest in individual stocks, however, let the gloom and doom work to your advantage. Get greedy when other people run scared. If you see a great company being unfairly punished, buy some stock or add to your position.

I think that over the next year or two, there is going to be a really good buying opportunity for some of the homebuilders such as Lennar, DR Horton, Pulte Homes etc... It could be right now, it could be next week, or it could be a year from now. I can't predict that with any certainty, however, I can definitely say that there is a considerable amount of uncertainty over these companies right now. I dipped my toe into the water by buying some long dated DR Horton options that are currently worth about 50% less than I paid for them a few months ago (allthough they do not expire for another couple of years, so they might turn out to be a smart purchase yet!) I was definitely early in buying those options, and as Bill Miller put it recently- being early is sometimes the same thing as being wrong.

If you're interested in looking into investing in homebuilders, I recommend you read this article about Bill Miller's early call on buying these stocks.

There are a few good quotes in there, notably:

Investing in an industry or company amid its worst performance in years or
decades can, though not always, prove quite profitable if the performance isn't
measured in days or months, Miller said.

"The headlines today are all about this being the worst housing market
since the early 1990s. Had you bought housing stocks during that previous period
of duress, you would have made many times your money and handily outperformed
the market over the subsequent decade," he said.

Another company I've had my eye on lately is Universal Technical Institute (NYSE:UTI), a small cap company (about $500m market cap) that runs automotive training schools and has a contract with NASCAR. The Motley Fool introduced me to this one. I haven't had a chance to look into it too much, but over the past week or so, the stock has taken a big hit that seems less related to the company's prospects than it does to the overall market decline. It's definitely worth further investigation.

An Idea for Locking in a good Mortgage Interest Rate

I've been floating this idea around in my head on and off for a while now, and the recent slight dip in treasury yields (which form the basis for mortgage rates) pushed it back up to the front of my mind. It's not perfect, there's a chance it has been done already, and it may not even work in practice, but here goes...

So I want to buy a house. I am going to need (for example) $200,000 in addition to my cash on hand, which I will have to mortgage. Treasury yields have fallen a bit lately, so let's say that even though I dont have a house, I plan to buy one in the next couple of years, and I want to borrow my $200,000 at 6% now because I think rates are going up.


I envision a product sold by a financial institution that would let me borrow the $200k at 6% provided I invest the $200k, plus my $100k down payment, in a portfolio of high-grade bonds, for example AA corporates, until I take it out and use it to purchase a house. As of today, corporate bonds that mature in 2 years yield approximately 5.28%.

The quality of a diversified, highly-rated bond portfolio should be enough security for the bank to offer me the money at mortgage rates, especially given my high credit score. So anyway, I have my $300k locked away in a separate account where the yield on the bonds pays me a taxable $15,840 a year (.0528 x $300,000). The interest on the mortgage is $12,000 a year, which the bank can take comfort in the fact that I have $300k in assets earmarked in a separate account to generate that kind of income. Depending on how regulators and the IRS treat this $12,000, I would argue that it deserves tax-deductible treatment like any other mortgage. The excess between the $12,000 and the $15,840 would add to the account value.

When the time comes to purchase the house, I liquidate the portfolio and pay the cash to the seller.

Of course there's plenty of hair on this dog, but that's the bones of the idea.

I have no idea if this has already been done, or if there's something I'm missing. Just throwing that out there. Feel free to pick it apart, internet dwellers!

Mid Year Review

I like to sit back and reassess my savings and investment goals every now and then. Today being the first of July, I did my mid-year review of my house savings, retirement accounts etc...

Looking back at my year end review - the markets had extremely solid returns in 2006 (the S&P returned about 15.8% last year) and these returns have slowed just a little in 2007, although the year isn't over yet. The bulk of my retirement assets are in an S&P Index fund, which is up just a bit more than 9.3% on the year. Amazingly, my emerging markets fund is up 22% so far this year. This compares with a 30% return last year. If I had put all of my money in this fund (instead of only 5%), I would be a very happy man today. However, I stuck to what I consider to be a more prudent long-term allocation scheme, and I'm sitting around the same percentages as I was at year end.

Some people have asked me for some specific numbers...I do track them, but I don't publish them very regularly. I now have $50,000 in my 401(k) account, and I contribute 15% out of every paycheck (pretax) into the account.

I have also been saving for a home down payment, and that has been progressing nicely. Since we live off my wife's paycheck, I have been fortunate to be able to deposit my entire paycheck into a separate account we have earmarked for a home purchase. Currently we have about $125,000 in that account, which puts us very near our goal of $150,000. We plan on purchasing a home for $300-$400k, and in addition to a down payment, I want to have a good cash safety net, as well as some extra cash for incidentals such as furnishing and repair.

The news on the housing front has been very positive for me lately. Sales are down, foreclosures are up, and hopefully this will lead to a more meaningful price correction. Bad news for homeowners and sellers is usually good news for potential buyers. However, interest rates have been climbing lately, which almost cancels out price declines. I wrote a post about this recently.

I work in finance and I consider myself to be pretty good with numbers. If conditions don't seem favorable to me (home prices and mortgage interest rates), I am happy to sit on the sidelines until some normalcy returns to the market. I think this is beginning to happen, but I am not convinced yet.

My home savings are now in an ING Direct Electric Orange checking account earning 5.25% APY, or about $440 a month in interest. You might recall a previous article where I decided against opening up an electric orange account. However, given the favorable rate of 5.25% for balances above $100k, and the fact that I have been able to get my balance above $100k, I decided it was too good (and too liquid) to pass up. My previous objections mainly centered around a suspicion that the rates were just "teasers" that would go away quickly, however they have remained high for a while. Also, even though I have been trying to keep fewer accounts outstanding, the electric orange account integrates nicely into my ING Direct accounts page, so it is not much work to keep track of it. Finally, I'm only using my Electric Orange account as a savings account so I am keeping my Chase accounts to make bill payments and write checks out of.

So to sum it all up, I've been able to add about $15k to my down payment fund in the first six months of 2007, and $10k to my retirement accounts (these figures include both mine and my wife's accounts). I hope to be able to top this and add $20k and $15k over the remaining six months of the year. We had some large expenses in the first half of the year, including a large charitable donation, car repairs, a hefty tax bill and some generally wasteful spending. I hope to be able to cut down on these things over the rest of the year!

Mortgage Rates Are Rising - How Will This Affect Home Prices?

Check this out... back in 2002, the yield on the 10 year treasury was about 3.5%. Mortgage rates, which are based off of that rate, were in the neighborhood of 4.6%.

So your monthly payment if you took out a $200,000 mortgage in 2002 would have been something like $1025.29 per month.

Fast forward to today. The yield on the 10 year treasury is about 5% (bloomberg.com) and rising. Mortgage rates are about 6.1%. Your monthly payment for the same $200,000 mortgage would be $1,211.99 per month. $187 dollars more per month purely in interest. Thats $2,240 more every year, or $67,212 dollars over the life of the mortgage, just because of the change in interest rates.

Can you see why so many people bought so many houses back in 2002? The monthly payments were pretty darn cheap.

It's impossible to predict where rates will go but it is easier to see them going higher rather than lower over the next couple years. Rates are another factor that affects demand for buying houses.

As many of you know, I'm hoping to buy a house within the next few years. I'm also hoping that increases in interest rates hopefully lead to more housing price reductions, because fewer people will be able to afford those higher monthly payments.

Hedging a Home Purchase?

Using my play money in my play account, I recently purchased a few long-dated call options linked to D.R. Horton, America's biggest homebuilder. Call options are basically a leveraged bet that a stock is going to go up.

There wasn't a whole lot of news on the housing front in the past couple of weeks until today, when treasury secretary Henry Paulson went on CNBC and said that the housing slump is largely over.

As a result, DR Horton's stock (NYSE: DHI) was up about 4%. Being a leveraged bet, and due to a general lack of liquidity, the particular DHI options I own traded up about 25% today.

This got me to thinking... as a young couple looking to buy a house in the next few years, how could my wife and I protect ourselves from an increase in home prices? We have a chunk of money (approaching $100k) saved for a down payment, but how could we protect ourselves against an increase in prices? What if the housing slump doesn't last like we're hoping it does and prices jump next year or the year after?

One thing we could possibly do is to spend a portion of our savings (say $5-10k) buying call options on - you guessed it - homebuilder stocks. This way, if the housing market rebounds, the value of our options will increase, hopefully offsetting the increased prices of our target homes. If the prices on target homes go up by, say, $20,000, the value of our options would ideally be $20,000 or greater.

Of course, this is just a rough sketch of an idea that I haven't thought through fully, and homebuilder options in no way represent a perfect hedge on housing prices due to the fact that the homebuilder's stock price is not directly correlated to prices of homes in the areas we are targeting.

Anyway, that's just food for thought. It would be irresponsible for me not to insert another disclaimer here... that you should NEVER put the money you've saved for a house into an investment as risky as options unless you completely and fully understand each one of the myriad of risks that would be associated with such a strategy. I'm not going to actually do this, but I thought it was an interesting idea nonetheless.

Can't Short These Subprime Lenders

Shhh! Don't tell anyone, but I've had a small trading account for about 8 years now. I use it as a way to make more speculative stock market bets. It is purely money that I can afford to lose, and I have considered it part of my financial education. (I opened it when I was 20 years old, but my first few stock trades were in my teenage years via my father's account). I make a clear distinction between that account and the accounts I use for investing.

Anyway, I decided I would try to short a subprime lender or two in this account today because I think there is more pain coming in this sector. However, when I tried to do so in Ameritrade, it told me that there was "no stock available to short" for the particular companies I tried.

Shorting is a way to bet on a stock going down, for those of you who are unfamiliar with it. It can be very dangerous, but I had some limits in mind in case the stocks bounced (hardly likely).

I guess shortable stock runs scarce when these companies implode. One of the companies I was going for in the morning was Accredited Home Lenders (LEND), it ended up dropping another 20-30% after I tried shorting it, telling me it would have been a good bet for a one-day gain.

Some of the stories I read today mentioned that around 13% of subprime loans were delinquent, or had payments 30 days past due. Some others mentioned the possibility of government aid to people who were missing payments on subprime loans. This made me extremely angry.

People who bit off more than they could chew in terms of mortgage payments do not deserve to be bailed out. They deserve to have the second homes, investment condos and other properties they bought hoping to flip (bidding up prices and pricing people such as me out of the market when they did it) taken from them. Foreclose on the homes that have mortgage payments people can't make. These homes will be sold to people who can make the payments, most likely at more reasonable prices, and the market will return to equilibrium where people who have saved and can afford houses will be the ones who own them, not people who are financially unqualified.

I have said it before and I'll say it again- I hope subprime foreclosures wipe out the real estate speculators and lead to a large correction in home prices in 2007.

The Subprime Mortgage Default Opportunity

Subprime mortgages have been in the news quite a bit lately, and the news has not been good for subprime borrowers and people who own stock in subprime mortgage lenders. For those of us in the market to buy a home, however, I think the news is actually very good.

If you have a high credit score, you can usually get a mortgage at a pretty good interest rate, let's call it somewhere around 5.8% for a 30-year mortgage today, according to Bankrate.com. However, if you have a low credit score, you are considered a risky borrower, and must therefore pay "subprime" rates sometimes well in excess of the 5.8%.

During the housing boom of the past 5-10 years or so, many people with shaky credit histories, low incomes (as compared with their mortgage payments), and low credit scores were able to borrow money to buy houses as banks relaxed their guidelines around granting loans to these "subprime" credit risks. They used tools like adjustable rate mortgages, interest-only mortgages, and other creative kinds of financing to get people into their homes (or to buy them their investment properties).

This was all well and good in the low interest rate environment we've enjoyed for a long time, but as interest rates have come up over the past few years, these shaky buyers have been increasingly unable to make their mortgage payments and going into default.

The big news that put subprime defaults on the map recently was HSBC's profit warning, where it said that it was going to increase its provision for loan losses by 20%. This warning was followed by others, all of which blame increasing subprime loan defaults for unexpectedly poor results.

Dan Green over at The Mortgage Reports Blog has been following the news and even created a category- subprime shakeout - on his blog for the related news.

I have been silently cheering a housing market decline for the past couple of years because I recently got married and have been saving money to buy a house. With the way the market has overheated, it became clear to me that I would never be able to afford one (especially in New York) unless prices came down. Like a lot of people in the USA, the housing boom simply priced me out of the market.

Mortgage defaults may be a good catalyst to drive prices down. As people realize they can't make their monthly mortgage payment, one of their options is to sell their house and try to use the proceeds from the sale to pay off the mortgage. They truly become "motivated sellers" and will make price concessions to get the house sold so they can stop hemorraging cash via large monthly mortgage payments. Home prices are usually based on comparable sales, so if one home in a neighborhood is sold at a "below market" price, the price tags on other houses in the neighborhood will usually come down as well. This could present a great opportunity to buy a home for a decent price.

Now before you villify me for cheering a housing price decline, let me clarify a point here. I'm not hoping that families are put out on the street. That is the last thing I want. Instead, I want to see speculators and investors leave the market.

I think a big cause of the housing boom was investors buying second and third homes as speculative properties, hoping prices would go up and planning to "flip" the homes for a quick profit. I personally know some people who did this and these people are currently sweating bullets because the quick profit did not materialize. Instead, the value of the homes and condos they bought have actually declined, leaving them stuck with adjustable mortgages bearing rates that are moving higher and higher. If they sell, they will realize a loss, but that is a risk and it is all part of the game they were playing.

At any rate, for all of us who have been hoping to buy a home, but felt hopelessly priced out of the housing market due to speculative excesses, we can let out a silent cheer each time we see a subprime mortgage lender report that defaults are rising. As the motivated sellers run for the exits, we will be there with open arms, ready to take the home off of their hands for 20% down and 25% off of the asking price. We just need to be ready for the opportunity.

I'll leave you with one of Warren Buffett's mantras for investment success: "Be greedy when others are fearful, and be fearful when others are greedy." I am in no way a real estate expert, but I think the next few years might offer some opportunities to be greedy in the housing market.