Advanced Personal Finance

The following was a guest post I did that was featured on Money Smart Life.

Marketing and advertising has always held a certain interest for me. Right now I’m reading a book that discusses how people influence other people.

There’s a principle called reciprocity that says people are more apt to do something for someone who has already done them a favor. Makes sense and I’ll bet everybody can cite an example of reciprocity in their life. It’s how most of us moved during college.

What’s interesting is that reciprocity works with strangers and even people you don’t want to help at all. For example, an exterminator gives your house a free inspection. You’re much more apt to buy a treatment plan from him afterward than if he’d just tried to sell you on it without the inspection.

Yeah, yeah, get to the part about Victoria’s Secret

Odds are, reciprocity has affected you. Victoria’s Secret uses it all the time.

Fairly regularly, they send people a certificate for a free pair of underwear - no strings attached. When we use it, though, reciprocity tells us we should really probably buy something else. After all, Victoria’s Secret was nice enough to give me a pair of undies for nothing. I should really return the favor in kind and do something nice for them.

This works even when the product isn’t lingerie. But then again, how much persuading do you need to buy lingerie?

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In reading about the housing market and the Bear Stearns hedge fund collapse, I’ve come to wonder about mortgage brokers. I mean, I know what a mortgage broker does. What I’m not sure about is why someone would use one.

What a Mortgage Broker Does

A mortgage broker matches lenders with borrowers. It’s as simple as that. They are not lenders themselves. The broker is supposed to guide borrowers through the mortgage process, helping determine funding options.

The biggest selling point I can find for brokers is they are more familiar with what I’d call ‘more complicated’ loans. Many borrowers don’t know about piggyback loans (a second loan on top of your primary mortgage, usually used to avoid PMI) and stuff like that. The idea is the mortgage broker is the ‘expert’ so the borrower doesn’t have to be.

In exchange for this guidance, the broker gets paid a percentage of the mortgage amount by the lender. Some also charge the borrower fees, though I understand this is less common.

What Does a Broker Add to the Process?

I can’t figure out what, exactly, the mortgage broker really adds to the home-buying process from a borrower’s perspective. There is an inherent agency problem with using one - they don’t have to get you the ‘best’ loan. They work with a stable of favored lenders. That strikes me as fertile ground for abuse.

Here’s what the National Association of Mortgage Brokers has to say:

Why choose a mortgage broker?

Over half of all Americans do. Brokers provide consumers with:

* Choice
* Convenience
* Knowledge

The consumer receives a knowledgeable professional through the complex mortgage lending process. The broker offers the consumer extensive choices and access to many different types of home loans.

What’s so “complex” about the mortgage process? I’m hardly an expert, but I’ve bought a house and refinanced it once. I didn’t find it complicated at all. And with the internet, it’s not like I have to visit a bunch of banks or call a list of lenders to get quotes.

I guess the answer lies in the NAMB’s second bullet - convenience. If you use a broker, they get a bunch of quotes and give them to you. And for this I’m (indirectly) being charged 0.5% and 1.25% of the loan amount (the average contingency fee charged to the lender)? No thanks. I’ll navigate the “arduous, costly, and seemingly impossible” mortgage loan process myself.

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It is fair to say my family and I wouldn’t be where we are today if it weren’t for my wife. In fact, that’s a gross understatement. My wife is the reason we turned it all around shortly after we were married.

I firmly believe family is the key to personal finance success. You can carefully plan your 401(k) allocation; you can be frugal all day long; you can pay down credit card debt. If your family isn’t behind your efforts and 100% onboard, you’ll be wasting your time.

Our Story

My personal finance journey is going to sound familiar to a lot of people, so I’ll keep it short. I graduated college with several thousand dollars of student loan debt and several thousand dollars of credit card debt. Mine was a somewhat different situation after graduation than most. I was commissioned as an officer in the army, so I went to training for six months. During that time, I literally ate out every meal (we lived in dorms basically). I saved nothing. I paid the $15 minimum on my credit card debt.

Then I met my wife. We married not long after and she did something amazing. She got me on the right financial path. She did it with a simple action.

She insisted we save something every month.

We were still hurting because she was still in college. We were going further into student loan debt and trying to dig out of credit card debt. But we saved $100 per paycheck religiously. That simple act changed it all for me.

To make a long story short, we’re now debt-free (other than our mortgage) and save and invest every month.

The Family Factor

Had my wife (my family at the time) not been with me, we simply could not have recovered from the hole I’d dug us. We put vacation pay, bonuses, and gifts toward becoming debt-free. We budgeted. Our entertainment was inexpensive or free. We drove crappy cars.

And we did it together.

Today we make decisions together (and argue along the way sometimes) and once the decision is made - we’re in it together. Having everyone pull in one direction makes progress possible. Family behind you is the key ingredient to financial success.

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This is a guest post I wrote for Five Cent Nickel this week.

There’s an interesting wrinkle developing in the ongoing housing bubble/sub-prime saga. It looks like many large banks may be coming to the rescue of defaulting borrowers. Why would they do something like that? Because it lets them avoid huge payouts to hedge funds.

Credit Default Swaps

There’s a common derivative called a Credit Default Swap (CDS). It’s essentially an insurance property against mortgage defaults. A Mortgage Backed Security (MBS) is sold by a bank to a hedge fund (or anyone else). To hedge the exposure, the fund buys a CDS that pays off big if certain default criteria are met. Interestingly, the hedge fund doesn’t even have to own the MBS to buy the swap. Kind of like taking out a life insurance policy on someone else with you as the beneficiary.

So what we have is banks lending money per their normal business model. But because they’ve also sold CDSs, they really, really, really don’t want people to default on their mortgages. If enough do, the bank will be on the hook for serious cash.

What’s a mega-bank to do? Help out the borrower, of course. Banks are rewriting loans to borrowers at risk of defaulting in an effort to prevent the default criteria from being met.

Market manipulation or good banking practices?

Hedge funds and other purchasers of CDSs are naturally not pleased with this development. They’re arguing banks shouldn’t be able to do this to avoid paying on the swaps. The hedge funds call it market manipulation. Banks say they’re doing nothing of the kind, they’re just trying to help the little guy keep his or her home.

Hedge funds have a real problem here for precisely the same reason they normally the freedom they do - they’re very lightly regulated. There’s no governing body to make the decision on whether what the banks are doing is ok or not.

So if you read or hear about banks benevolently reworking loan terms for at-risk borrowers, now you know that they’re not doing it out of the goodness of their hearts.

But you already knew that, didn’t you?

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The Digerati Life is hosting the Carnival of Personal Finance this week.

Here is a sampling of some of my favorite submissions:

Moneymonk writes about owning versus renting - your lifestyle.

Filam Personal Finance has a nice post about breaking the financial illiteracy within families.  This one hits close to home.  Passing on financial smarts was not one of my parents’ strong suits.

Flexo at Consumerism Commentary writes about a divisive issue - whether to pay off the mortgage early or not.  I found the comments particularly interesting.

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