Risk – Part 4

Earlier I talked about no one realizing risk until something bad happened. The fact is that risk is all around us. Sometimes, it makes the papers. Do you remember the Avian Flu crisis a few years ago? It did kill people who lived with infected chickens but the scenarios that spread from that were so bad that people were afraid to fly on airplanes. Many, many people cancelled travel plans and those who got on the planes all wore masks, as if those would stop an airborne virus.

As we learn more about this, it turns out that this really is serious and one well-regarded expert scientist has warned about a pandemic. He said

“The world is teetering on the edge of a pandemic that could kill a large fraction of the human population"

As this story has developed, over ten billion dollars has been spent to develop a cure the H5N1 virus. Frankly, as serious as it is, no one seems to worry about it anymore. When was the last time you thought about it?

Here’s another one that is closer to home.

Lucy Jones, a scientist with the U.S. Geological survey said last week that the Coachella Valley area of Southern California – read “ Palm Springs ,” one of the fastest growing areas – was over 100 years overdue for a major earth quake. She said that:

“ the shaking could last more than 100 seconds, kill thousands, destroy homes, collapse the I-10 and I-15 freeways, ignite petroleum pipelines and leave untold thousands homeless in potentially searing desert heat. The long-term effects, she said, could be akin to the economic collapse of New Orleans and the Gulf region following Hurricane Katrina.

Now, how’s that for someone laying out a risk scenario? Yet, my guess is that if you went down to Palm Springs anytime soon, you’d find that real estate activity was virtually unchanged from a week ago. Should we actually get such a quake, it will likely be far enough in the future that no one will remember Lucy’s warning.

So it goes with junk mortgages. I sit in the epicenter of the junk mortgage meltdown with many of the industry’s (formerly) biggest players just a few miles away. I could see that their business practices were encouraging the development of loan products that were potentially dangerous to borrowers. I could see that the outrageous commissions being paid to loan officers were encouraging unethical business practices. I could see that the lack of regulation stimulated the growth of the junk mortgage industry.

Finally, I could see that gazillions of borrowers were being sold irrational mortgages that would jeopardize these individual homeowners who were talked into taking stupid loans. The chickens are finally coming home to roost, which is why it has been important to get a better understanding of the forces at work.

So assume that you want to buy a home today. What should you do to avoid risk? The first thing would be to find real estate and mortgage advisors who are going to give you honest advice. You can best find one of these by getting referrals from friends.

Second, get an education. If this series on risk has stimulated you, you will be delighted by how much more there is to learn. Consider buying my highly praised book How to Save Thousands of Dollars on Your Home Mortgage. The best part? That education will help you make better decisions and each good decision will save you thousands of dollars.

As to specific risk advice, there are some things you should do and things that you should not do. Number one: Don’t buy a home unless you can afford it with a sensible mortgage. You should not buy it if you can only appear to afford it because of some initial low payment loan. Buy a smaller home or buy a cheaper fixer upper and get to work.

Next, avoid mortgage risk for as long as you are likely to own your home. The mortgage industry has loans that are fixed for six months, one year, two years, three years, five years, seven years, ten years, fifteen years, thirty years, and forty years. Pick a term that fits your situation.

Third, do not get a loan with a pre-payment penalty. Most of the time, that’s something the loan rep sticks in there because he gets a higher commission. When you sign loan docs, make absolutely sure that it’s not there.

Fourth, these days there is no need to consider any type of Adjustable Rate loan. Especially to be avoided are the so-called Option ARM. These are sucker loans with very low payment rates and spell real trouble. These loans are a significant part of the cause of the current problems.

Wrap up

I hope that you have learned something from this little trip down Risk Street . Like most problems, the way it will finally turn out will likely be better than is currently anticipated by the markets. The fact is that the world is NOT coming to an end. In fact, when you look at the size of the problem, even if there are a lot of foreclosures, it affects a very small percentage of the U.S. housing stock. The unemployment rate is low, job creation is at acceptable levels, and most homeowners are sitting in homes with good equity and a payment that is easily affordable.

That does not mean that these problems are going to get sorted out easily or quickly or that there won’t be some more casualties. There will be. In fact, I can see that the stock market traders are doing a good job of dismantling some fine companies that have mortgage exposure but not of the junk mortgage kind. The very good news is that we have a very resilient economy that has a way of blowing past problems, but it will take time. That will be the case here too.