What Are You Doing to Prepare for the Economic Recovery?

By Rebecca W. Bass

Branch Manager, Element Funding Mortgage Bank

While headlines and presidential speeches continue to warn that “things will get worse before they get better”, the economic barometers indicate that the economy will start to show significant signs of improvement in the next 9-12 months. Even the bad news is less negative than it has been in about two years, a sign that the recession is slowing down and a recovery is on the horizon.

The question is, “What are you doing to prepare for the economic recovery?”  If you believe that there will not be a recovery, then you should probably start packing and figuring out where you are going to live. If, on the other hand, history and your own experience tell you that economies improve and decline in cycles regardless of what the government does, there are some important maneuvers you should be doing right now so that you are in the best position to maximize your financial position as the economy rebounds.

As you may be aware, mortgage interest rates are currently at levels not seen since the mid-1950’s. Many savvy homeowners have already refinanced to take advantage of these historically low rates. Others are waiting to refinance, speculating that rates will go even lower. The problem with that strategy is that present rates are artificially low. Mortgage interest rates have been bouncing between 4.50  and 5.00 percent because the Federal Reserve initiated a program of buying mortgage-backed securities. Before the Federal Reserve program was announced, mortgage rates were around 6 percent. But even that was considered a great rate at the time. To provide some perspective, during the Carter Administration in the 1980’s interest rates reached over 20 percent – that’s right, 20 percent interest on home loans! Doesn’t it make sense to consider locking in a rate now that has not been seen since Communists were the only threat to our way of life?

The last two weeks of May have shown just how unforgiving the markets can be for people who choose to procrastinate. In just five days, interest rates increased anywhere from .50 to 1.00 as fixed-income investors demanded a higher return on their money. As the government spends money on stimulus programs it will have to sell government bonds or notes to raise the money it is spending but does not have. As government bonds compete with mortgage-backed securities, investors will go with the highest rate offered, spurring an increase in interest rates on bonds and home mortgages.

If you are a homeowner with an adjustable rate mortgage (“ARM”) and you are planning to remain in your home beyond the fixed rate period of your loan, now may be the opportunity of the decade to refinance your ARM to a fixed rate loan before we return to the interest rates of the Carter Administration. Lenders are tightening their standards and applying more restrictive underwriting guidelines. In today’s credit market this means you will need a credit score of 620 or better and the ability to prove your income with W-2’s and pay stubs. In addition, you will need to show reserves by providing two months of bank statements showing the liquid assets in your savings, investment and/or retirement accounts.

Many homeowners utilized a home equity line of credit (“HELOC”) to facilitate their home purchase in the past couple of years. Most HELOC’s require only interest payments and the rate has the potential to change every month with changes in the prime interest rate. As prime has fallen over the past year or so, these homeowners have enjoyed the fact that their minimum payments have been going down. The administration in Washington is attempting to improve the American economy. Everyone wants the plans to succeed, but homeowners with HELOC’s need to understand that as the economy improves, the prime rate will start going up. This will mean higher minimum payments. The smart thing to do now is to prepare for this inevitable outcome by paying down the principal on your home equity line of credit.

If you have a significant equity position in your home but you don’t have the cash right now to pay down or pay off your HELOC, consider refinancing your current home mortgage to include your outstanding HELOC balance in your new first mortgage. The result—you will be locking in an historic low rate on your mortgage while at the same time eliminating your exposure to higher interest rates on your home equity line.

Bottom line: If you have not yet refinanced your home loan to take advantage of rates from the “Leave It to Beaver” era, now is certainly the time to discuss the possibility with your mortgage banker to see if you qualify to have your financial situation improved by a refinance.

As far as credit cards are concerned, beware of offers that look too good to be true. A current example is Chase’s recent offer to 25 million customers to skip their June payment, setting those customers’ minimum payments to zero. Sounds great, doesn’t it? The big banks are really going all out to help the battered American consumer, right? Well, here’s the catch—finance charges continue to accrue on the unpaid payment. Chase makes more money from non-payment since they can put another month of high interest on the existing balances.

Another tempting credit deal is from credit card companies or retail stores that offer to let you open a credit card today and get 10% off your total purchase. Bear in mind that even if you pay off the balance in full when your statement arrives the available credit on this card appears on your credit report. The fact that you have added another open account can bring down your credit score and increase your overall debt to income ratio. The impact of this is that you may not qualify for a refinance at today’s attractive interest rates. Another way that credit card companies are impacting credit scores is by abruptly increasing the interest rate charged on new purchases. Further, they are reducing the credit limit on current card holders to the amount of the principal presently owed by the cardholder. When credit limits are reduced, the computers at the credit card companies conclude that the borrower has now maxed out his new, lower credit card limit. Because credit bureau computers are concerned with the ratio of available credit to credit utilized, they are quick to hit your credit score when this happens. My advice-- do what you can to pay down or pay off your credit cards. They carry high interest rates that are subject to change at the discretion of the issuing bank. In addition, the more you can pay down the balance on your cards as a percentage of the total credit line, the better your credit score will be.

If you are thinking of purchasing real estate, there is no question that now is the time to buy. If you are a first time home buyer, the federal government is offering you “FREE MONEY”. If you close on your home before December 1, 2009, you could be eligible for a tax credit of up to $8000. Prices of homes have declined to 2003 levels in many cases and coupled with the extremely low interest rates available today, this may be the best time ever to buy your first home. But be mindful that  this tax credit is actually a loan from Uncle Sam that is expected to be paid back in the future.

As the economy shows solid signs of continuous improvement, the prices will start to go up. Interest rates are artificially low right now, and will surely rise whether the economy improves or not and inflation becomes a real concern for long-term interest rates. If you follow my advice, you will be in a position to benefit from an economic recovery or at least ride it out in a safe harbor until it does recover.

Rebecca W. Bass is Branch Manager of Element Funding Mortgage Bank in Beaufort. She may be reached at 843-379-0999 or by email at rbass@elementfunding.com.