Tuesday, July 26th, 2011
If you’re a newcomer to sorting out your personal finances, then you may find yourself perplexed by the amount of jargon that appears on the advertisements and websites of banks and other financial institutions. You might do a web search or use a dictionary to find out what all of these financial terms really mean, but could still find you’re still muddled by the lack of decent explanation. If you still think you need some help, then take a look at this handy list of financial terms.
Collateral
Collateral is used to describe an object of high value that is used to guarantee the repayment of a loan. If repayments are late, or the agreement is defaulted, the collateral is taken in place of the repayment. Amongst the most common types of collateral are people’s houses in regards to their mortgage payments, or their cars if ‘part-ownership’ deals have been made. Therefore, mortgages are amongst the most common loans with collateral. For some of the top rates on mortgages, take a look at NatWest.
Secured and Unsecured Loans
A secured loan is one that has collateral back it up in the event of default, they usually have lower interest rates due to the fact that if payment isn’t made the lender has the ability to take ownership of the collateral and sell this to make up the money that they are still owed.
Accordingly unsecured loans are Loans that don’t have collateral. Instead they charge much higher interest rates so that if the repayment is unable to be made, the lender will already have received back much of his original capital and therefore make the smallest loss. Alliance and Leicester is provides some of the best rates on loans available from the reputable high street banks. Also, take a look at ASDA Finances for low rates on both secured loans and unsecured loans.
Equity
Equity refers to the monetary value of a property or business after the amount that is still owed on the loan originally used to purchase it is taken off. Most commonly that loan is the mortgage on someone’s house, which means the equity is the part of the house that is owned directly and solely by the individual and not the bank, or mortgage lenders. The more money that a person pays towards their mortgage then the more equity that they are considered to have.
Equity, therefore, is linked to collateral in as much as it is the equity that an individual holds on their house that is considered as the collateral in mortgage agreements.
Default
Defaulting is when an individual is unable to fulfill their obligations in regards to a financial agreement. Simply put, if you are unable to meet the payments of a mortgage, or of a loan, then this is considered defaulting. In regards to the current global credit crunch, the problems are simplistically assigned to large numbers of people defaulting on their mortgages in America. This was due to certain financial institutions taking the risk of agreeing mortgage terms with people who would not certainly be able to meet the terms of their mortgages.
These are just a few of the simplest terms that are found when addressing personal finance, particularly in regards to loans, credit cards, bank accounts, and mortgages. It is important to be closely familiar with them when dealing with anything financial, as slight misunderstandings can have incredibly grave consequences.
Posted in Investor Education | 4 Comments »
Saturday, November 13th, 2010
The topic of paying down one’s mortgage vs. investing seems to be a never ending debate with everyone having their own opinion on which method is better.
The argument for either side of the equation usually heats up over the topic of investment return. While some argue that investing can yield a higher after tax return based on historical figures, others posit that those historical figures are likely not going to be accurate going forward and that finding a ‘guaranteed’ rate of return in the current environment as high as your mortgage rate is improbable.
While both can make good arguments, I am not going to approach the mathematical side of this subject with this article.
The truth of the matter is that everyone’s situation is different and everyone has their own personal views on risk and debt. Truth be told, I firmly believe that we can’t reasonably compare an investment portfolio with one’s personal residence. Therefore, I view this argument as much more emotional than mathematical. It is for that reason that I want to bring to light some of the emotional trigger points that evoke the polar responses often associated with the pay down debt vs. investing debates.
Let’s start with a few basic questions that may help you decide whether it is better for you to invest or to pay down your mortgage.
1.) How many years are remaining on the current amortization of your mortgage?
If you have fewer than 10 years remaining on your mortgage amortization and your rate is fixed until maturity, you may be better off taking the guaranteed return associated with retiring your mortgage early. The reasoning behind this is that, while investments in the stock market may yield a higher return on average, ten years is a relatively short period of time to invest in the stock market. This is especially true when we consider the necessity to achieve after-tax returns greater than your mortgage interest rate.
2.) Do you have the financial discipline to invest 100% of the amount of your mortgage payment once it is paid off?
If you choose to pay off your mortgage prior to retirement, you will have some catching up to do with respect to your investing goals for retirement. While there is peace of mind involved in being ‘mortgage free’, diverting that former mortgage payment to an investing/savings account is the perfect way to beef up your retirement portfolio. the opponents to the pay off the mortgage early plan often cite the tempation for the new found cashflow to lure you in to a lifestyle that you won’t be able to afford once your working days are through.
3.) How confident are you in your investing abilities?
While I like to think that by investing in dividend growth stocks and dividend paying ETFs, I don’t always make the perfect investment. Yes, I even lose money sometimes 
According to the statistics, most of us do not have the ability to consistently out perform the stock market indexes. What’s more, none of us have the ability to move the market which puts us at a further disadvantage. So, I must agree with Five Cent Nickel on one benefit of paying off the mortgage early:
Another advantage of paying off your mortgage early is that doing so protects you from yourself. While paying the minimum on your mortgage and investing the difference might sound like a great idea, there are no guarantees that you’ll actually follow through on the second part of the equation.
4.) What is your current state of job security and liquidity?
This is where we have to take a long, hard look at our personal situations and assess those things that could derail even our best laid plans. If you are confident in your job security and are comfortable with lower liquidity as you aggressively reduce your mortgage, then mortgage reduction may be the decision that is best for you. However, if job security is a question or if you are the sole breadwinner in the household, you may be more inclined to carry a higher level of liquidity (ie. larger emergency fund).
So, what am I doing?
I took a similar approach to this question that The Financial Highway suggests. Look at both the mathematical and emotional aspects of the equation and answer honestly to the above four questions.
Well, I am somewhat confident in my investing abilities, but the emotional side of me would like to eliminate my mortgage. However, the real benefit for me in eliminating the mortgage is in the increased cashflow provided from the complete elimination of the debt.
You see, my mortgage rate is variable and currently at 2.25% 2.50%, so the idea of paying extra payments instead of investing has little merit in reducing the overall interest paid on my mortgage.
Comparatively, saving/investing until I can eliminate the debt entirely will have the effect of keeping my funds liquid as a hedge against job loss or another financial tragedy until such time as I can mitigate the risk of job loss etc. by removing the entire mortgage payment from my liabilities.
What are your thoughts on the invest vs. pay down mortgage debate?
Resources:
Mortgage Pay Down vs. Investing Calculator
Posted in Debt | 6 Comments »
Wednesday, May 20th, 2009
Since the credit crisis began in August 2007, experts have agreed that there is no magic bullet solution. The general view is that world economies will eventually recover but the healing process will take time. Along those lines, here is REAL data that represents REAL steps in the right direction.
Here are two recent examples:
- Global credit markets continue to thaw as government cash injections and interest rate cuts kick in. Last Friday, the London interbank offered rate (Libor) – the interest rate banks charge each other for loans – fell the most in eight weeks to 0.85% for three-month U.S. dollar loans. Libor, which determines rates on everything from car loans to mortgages, peaked at 4.82% at the height of the financial crisis last October. Last Friday’s fall in three-month Libor was the 33rd consecutive day of declines – the longest stretch dating back to January 2008.
- Last Friday also marked the 10th consecutive day of gains for the Baltic Dry Index, which tracks ocean shipping rates for commodities. This was the longest advance in three months and the index hadn’t been that high since last October. The index is followed by economists since it can provide insight into the level of demand for raw materials in global markets.
Whether it’s banks starting to lend again, demand for raw materials picking up around the world, improved housing affordability in the US or the fact that the stock market rally since March 9th is now the largest and second-longest rally in the past 18 months, it seems step by step the pieces required for recovery are falling into place (albeit baby steps).
That said, the recovery path could still look like “one step forward, two steps back” for a while as we were reminded last week by weaker than expected April retail sales in the US and soft Q1 manufacturing sales data in Canada.
However, we can see that the LIBOR rate, the key indicator for credit movement, has decreased drastically. By all economic measures, this is a great sign for business and as such, a good sign for investors!
Posted in Investor Education | 5 Comments »
Sunday, August 31st, 2008
I have recently received a few e-mail comments from readers asking me to expand on my previous article Understanding Mortgages, this article will answer many of the questions that were posed to me in those e-mails.
Mortgage and Housing Markets
Today’s housing market in most of the United States is a virtual candy store for the homebuyer. The sheer selection of properties on the market in most cities allows today’s homebuyer a tremendous selection at prices we have not seen in many years. There is only one problem however – lenders are tightening the purse strings on mortgage financing!
With lenders becoming more and more risk-averse, obtaining a suitable mortgage these days can often be a daunting task. There are numerous types of mortgages to choose from, and because of some previous “shady” lending practices, you need to make sure that both your lender and your mortgage are on the up and up.
With that said, there are several different types and structures of mortgages with various options to consider before committing yourself to such a large obligation.
Once you have settled on a legitimate mortgage with acceptable terms and conditions, there is the issue of the interest rate. Which option you choose will depend on your circumstances, but visiting your lender armed with the knowledge of the basic differences in terms and conditions will give you the confidence to get the best deal.
Here’s a quick guide to some different types of mortgages:
Fixed Rates
With a fixed rate mortgage, you agree with the lender on a set period of time – usually between two and five years – during which the interest will not change. The benefit here is that you will not suffer an increase if rates go up. Similarly, you won’t benefit if rates go down, and the borrower will likely face stiff penalties in order to pay out the mortgage early. As intriguing as a low, fixed rate interest plan may seem, you must check how long you are required to remain with the lender before you can pay out the mortgage without penalty.
Variable Rates
The amount you pay for your mortgage alters in line with national interest rates. Normally, the interest reflects the changes in the base lending rate of the central bank; this is decided by the Federal Reserve whom control the monetary policy for the country. Every time the Fed raises the overnight rate, the lenders eventually follow suit because their cost of funds increases. And in order for the lender to make money there has to be a “spread” between its cost of funds (the rate the bank pays to borrow money) and what the back charges to lend that money to the consumer.
Capped Rates
The idea behind capped rates is to offer the best of both fixed and variable rates. A “cap” is set on the interest so that it will never rise above that level, but if national rates fall, your interest will go down accordingly. The benefit of these is that you know the maximum interest rate that you could end up paying. However, the capped rate is not generally very competitive.
Discounted Rates
Discounted rates will fluctuate in line with the lender’s variable rate, but are obviously cheaper to tempt customers in. After the discount term has ended, the rate will then revert to the normal variable rate.
Banks and companies offering mortgages are now required to supply customers with a key facts document that provides all relevant information relating to the loan, and clearly sets out the total cost of the loan, not just the interest.
What Else Can affect My Mortgage Rate?
Along with the various types of mortgages available, there are a few other things that can affect the rate of interest that you will be charged on your mortgage.
One of the major factors that will affect the rate of interest that a lender will charge for your mortgage is the risk that they perceive they are taking by lending money to you. The major tool that lenders use to judge risk is your credit score. A better credit score will result in a lower mortgage interest rate because you are determined to be a lower risk than someone who has a lower credit score.
Do Your due Diligence
Whichever mortgage you choose, make sure you thoroughly research every option and compare lenders. You are, after all, bound in to the agreement for a long-time, and it’s sensible to make sure you get it right first time as switching lenders can involve hefty penalties. Lenders may have significantly different terms and conditions for their mortgages.
Remember, that it doesn’t matter how low an introductory rate is if it will significantly increase in 6-months or 1-year. Be sure that you read the fine print and calculate the actual costs of the mortgage over the entire amortization period.
There are plenty of great homes out on the market right now and there are a ton of reputable lenders who will be happy to lend money for home purchases. The key is to be knowledgeable and well prepared when applying for a mortgage so that you ensure that you get the best mortgage for your situation.
Happy house hunting!
Posted in Debt | 2 Comments »
