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Dear Valued Client,
It has been an eventful few weeks. Governments around the world continued to roll out initiatives to combat the economic downturn, and here in the U.S. that has included the stimulus package, the TALF and the housing rescue program. Against this backdrop, markets registered new lows only to reverse sharply into a sustained rally the likes of which hasn't been seen in decades.
I'll provide our thoughts regarding the market as well as the overall economy below as prelude to the first quarter commentary coming next month. Over the last few months, we've made a number of ad hoc trades in response to market conditions, but as stability slowly returns to markets, our goal is to lay out a more formal strategy - barring major unforeseen events - next month.
One strong tailwind to economic recovery will undoubtedly be lower mortgage rates. Lower rates allow for more disposable income in consumers' pockets, which can only help shore up consumer spending. In the first article below, we look at the ins and outs of mortgages, and provide suggestions on how to compare mortgages if you're considering refinancing.
The question of the month also involves mortgages, and specifically the pluses and minuses of longer-term versus shorter-term mortgages. One final note, which is a housekeeping item - we will begin e-mailing out invoices and receipts in April, but if you'd prefer to get physical invoices mailed to you, just let us know.
As always, we welcome your feedback and questions, and feel free to forward this newsletter on to those you know that may find it useful.
Sincerely,
Micah Porter, CFA
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How to Compare Mortgages
Micah Porter, CFA
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If you've ever compared mortgages to determine which mortgage is "best," you have likely found the process more than a little confusing. There are so many variables to consider - from term to rate to closing costs to lock period - that making an apples-to-apples comparison can be difficult. Nevertheless, it can be done, and to do so, it's helpful to understand some of the basic mortgage characteristics. A few of the most critical are as follows:
*APR - the APR, or annual percentage rate, is a federally mandated calculation that should allow you to compare one loan to another. The APR begins with the base rate and adds in any points paid (more on those below) to determine the actual rate of interest paid on a loan. It is important to note that APR is calculated based on the assumption that the loan will be held through maturity.
*Points - there are two types of points associated with mortgages, and they are both expressed as a percentage of total loan value. The first type, origination points, are fees charged by a lender or mortgage broker to originate your loan. In essence, origination points can be thought of as a commission on the loan and 1% in origination points would equate to $2,000 for a $200,000 mortgage.
The second type are discount points, and one pays discount points to "buy down" the rate of the loan and lower your payments over time. The higher the discount points you pay, the lower your ongoing rate will be. Thus, a 30 year mortgage with no discount points might have a rate of 5% while paying discount points of 1% up front may lower the rate to 4.8%. Because paying points up front lowers the rate for the life of the loan, you may well decrease the total amount of interest paid by paying discount points if you plan on keeping the mortgage for a number of years.
Points impact the APR as the APR includes any points paid. Thus, this allows comparison of two loans of the same term and type but differing amount of points paid, and the loan with the lower APR will result in lower overall interest paid over the term of the loan.
* Closing costs - while some items, such as transfer taxes, included in closing costs are outside the control of the lender, others are not. Thus, closing costs among different lenders may vary, and in comparing mortgages, these costs should be considered. Lenders are required to provide a Good Faith Estimate (GFE) for a mortgage before you sign on the dotted line, and the GFE will contain a detailed breakdown of closing costs.
If you have a mortgage and haven't considered refinancing in the last year or more, it may well be worthwhile to check current rates. The above information should help in shopping around for mortgages, but don't hesitate to contact us if you'd like us to take a look at any mortgage you're considering as well.
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Thoughts on the Recent Performance of the Economy and the Markets
Micah Porter, CFA
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Judging where the economy stands, let alone where it is going, is a complex challenge. At any given moment, data is being released that is backward looking, roughly concurrent and forward looking. My sense over the last few months has been that backward looking data would show that the 4th quarter was a challenging quarter economically, and the first quarter of this year might prove worse or roughly the same, but it certainly wouldn't be much of an improvement.
The data that has been released over the last several weeks is bearing out that rough estimation. The bad news is the estimation of a very weak economy is correct, but there are also some tentative signs of good news.
First, forecasters have finally caught on to the deterioration of the economy and their forecasts are generally now roughly on target, or even a bit more pessimistic than reality. The second piece of good news is that in some areas such as consumer spending we seem to have found bottom, while in other areas like purchase of new and existing homes, the rates of decline have slowed. Both factors have likely been key drivers of the recent market rebound.
As for the market, it never quite reached the level at which we'd consider it a must buy. This may seem strange given the amount by which the market dropped, but bear in mind that whether a market is expensive, cheap, or somewhere in between is governed in part by the earnings of the companies that comprise the market. Earnings have dropped sharply, and if the recovery turns out to be slow and protracted as seems quite possible, it will take corporate earnings some time to recover. A slow market recovery would likely follow suit.
We're encouraged by recent developments, but will exercise patience. We'll likely scale back into the market over time, and there is a good chance barring any material unforeseen events that we'll continue to overweight bonds. Much more detail will be forthcoming in next month's quarterly commentary, .
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Client Question of the Month
Micah Porter, CFA
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Should I take out a 15 year mortgage or a 30 year mortgage?
The answer to this question isn't as straightforward as you might think. There are obvious advantages to the 15 year mortgage - typically, the interest rate is lower, and given that the life of the loan is much shorter, total interest paid is a good deal less for the 15 year mortgage. Nevertheless, unless your mortgage has a prepayment penalty - and we would never recommend entering into a mortgage that does have such a penalty - you always have the option of paying down your 30 year mortgage more quickly.
Here's a comparison of first year payments on a 15 year mortgage at 5% and a 30 year mortgage at 5.25% with a $200,000 balance and an assumed marginal tax rate of 25%:
As you can see, total interest payments for the 15 year mortgage are lower and a small amount of this is offset by higher tax savings. Over the entire 30 years, total interest paid on the 30 year mortgage is well over twice that paid on the 15 year mortgage.
So when should you choose a 30 year mortgage? If you think that due to declining or variable income making the 15 year mortgage payments might be challenging, you should consider a 30 year mortgage. Alternatively, if you're relatively certain that the payments won't present a problem, and particularly if you need the "enforced savings" that comes with a 15 year mortgage, we'd opt for that choice.
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