Posts Tagged ‘finance’

The Housing Bubble and Ensuing Mortgage Crisis

Monday, March 1st, 2010

The mortgage crisis caused the country and partially the world to go into a recession.  Why did it happen and how does it affect you and who do we blame?  During the 90’s administration, banking laws were deregulated thus allowing banks to act as investment banks.   Instead of banks just lending money and making interest, they could now invest in all sorts of different investment activities.  The situation did not seem bad at the time but increasingly became a critical ingredient to a perfect storm for a financial meltdown.

Next the banks started to Securitize the loans.   Securitizing a loan is when a bank provides mortgages to lots of people.  The bank then groups the loans together, any amount, and sells them to investors in parts or shares.  Now all the banks had to do was find a person who needed a mortgage to buy a house or wanted to refinance.  They would issue them a mortgage and then be able to sell it.  They also could hold it so it would look great on their financial statements.   On their balance sheets, it would look like a strong asset and on the income statement the bank would show large amounts of mortgage interest income.

The bank structure and the securitizing of loans made it great to be a mortgage broker.  A broker is an intermediary between the lender and the borrower and would try to find the borrower a loan and get a commission.  While brokers searched for loans, the banks in competition with each other to originate loans increased causing banks to loosen their terms and conditions.  First, putting down 15% instead of the normal 20% was okay.  Next, 10% was plenty, and then a person could borrow 105% of what the property was worth.  Even though you would pay a higher interest rate, 7-8% became cheap enough. People were able to take out lots of money from a refinance, or buy that Mansion they always wanted. Builders kept on building because people kept buying.  Then, banks started lending with no income verification.  If you had a decent credit score, you could get a loan. All a person had to do was sign a paper saying they were making whatever the bank wanted to hear.

Let’s assume I am buying a house for $500,000 and I cannot afford the $3,000 a month payment on the $500,000 house I just purchased (assuming a fixed rate of 6% over 30 years).  No problem! The banks will only require me to make interest payments.  As a bonus the bank will give a rate of about 2% for the first two or three years.  Now I can pay $840 a month for the mortgage on the house.   The house sounds great until two or three years later when principal needs to be paid and the interest rate jumps up 5 percent or more at one time.

Many Americans could not afford these large jumps and as a result people faced foreclosure.  In a lot of cases the loans were not interest only. In some cases there were adjustable rate mortgages where the rate automatically jumped up after an introductory period of anywhere between two and seven years.

Somebody needs to take the blame. How could banks be so liberal with their loans? Easy! Bank executives were the ones cashing in on the bonuses because the incomes of the banks were so high.  They were making a quick profit at the expense of building long term wealth.   An employee with Washington Mutual bank had threatened to go to the Federal Government and Securities and Exchange Commission to expose the situation, but employees with this knowledge eventually decided against being a whistle blower because of fears of retribution or losing their jobs.

Now let us look at the mortgage brokers. The broker’s job is to sell the loan.  That resulted in some brokers not telling people everything they should know about the loan.  An example of this is when people would get an adjustable rate mortgage where it had a low promotional rate for the first 3 years but then automatically when up by 5% or more.  The broker would say it became adjustable but would leave out the part about the jump.  Unless the borrower read the fine print, they were in for a surprise.  Brokers are paid by “points,” (a point is 1% of the loan value).  They would then encourage people to borrow more than they could afford in order to raise their commissions.  Another very illegal tactic that the brokers would do is falsifying documents.  It was not uncommon for brokers to create pay-stubs or tax returns for clients to show more money than they actually made.   Most lenders now require people to sign forms allowing them to verify the income with the IRS.   If you found crooked enough brokers, there was no limit to the forgery and or fraud that existed.

Home owners can share in the blame as well.  People wanted to borrow as much money as they could to get the best house possible figuring their income would only go up.  Everybody wants to do the best for themselves and their family, but people were not realalistic.  Soon principle and interest payments were due and the rates had adjusted to an amount that could not be controlled.  The only area of concern was getting into the house as soon as possible.

When a loan goes into default and a house or other real estate property goes into foreclosure a bank has to send several legal notices to the home owners in an attempt to get the mortgage up to date. If payment is not made, the bank will become the owner of the house.  In general, if the loan cannot be repaid, the borrower will eventually lose the house.  In Long Island, New York a judge in foreclosure case actually ruled that a couple was no longer responsible for their mortgage of around $500,000.  The reason he cited was the lenders complete disregard for the couple who took out the mortgage.  While this will probably be overturned on appeal, this does send out a very harsh message to banks.  In an appeal the court will only look at the application of law by the judge in the initial case and will not make rulings on the circumstances of the case.   In this situation the bank will not help the couple who took out the mortgage.   The likely result of will be banks becoming more flexible and compassionate toward lenders.  The federal government has also been encouraging banks to refinance people’s loans in order to make it easier on people.  Unfortunately only around 85,000 people have taken advantage of this out of the 50 million plus mortgages in this country.  One of the reasons why so few people took advantage is because people who really struggled but paid their bills on time were either not eligible or not offered help.

In an effort to fix the mortgage mess Congress had to get involved.  While they were not directly bailing out people in trouble I do believe it was necessary to bail out the banks.  If one of the large banks failed it would have had catastrophic results.  Many more people would have lost their jobs and all the investors in those institutions would have lost all of their investments.  The situation would have had a ripple effect on the market that would have made the recession much more serious than it already was and is currently.

The problem has a solution as do most problems.  On the loan side more needs to be required from potential borrowers.  Interest only loans should be only issued in rare cases to people with outstanding track records. Those types of loans should also only be given to people with proven track records.  The adjustable rate mortgages should not be given out to anybody including “subprime borrowers,” who are borrowers with credit scores below 620.  This way there is no chance of the payment jumping up to the point where the loan is no longer affordable.  Thirdly, people should be required to put down a substantial amount of money; at least 10% plus closing costs.  The more money put down would give people more of a financial interest and the banks a little cushion in case the market does take a dip.  If these procedures are done along with legitimate verification of loan documents, the system would be more efficient.  The house prices also would not go up as high or as quick because less people would be able to bid as high as they were able to during the buying frenzy.  Right now as the markets begin to recover housing prices are getting more stable.  Even with all these procedures foreclosures are still inevitable but the percentage of loans in foreclosure will drop.

If you have been foreclosed upon, there are things you can do to fight back from a financial perspective.  If you are in dire straits, start to prioritize.  Cut expenses such as: cable, going out to eat, and entertainment. Do not spend any more money on paying off your credit cards since the debt is unsecured debt which means the credit card companies cannot take your house, car, boat or other possessions in order to satisfy the debt.   Your credit score will suffer tremendously but when you are in this position your credit score matters less.  Next, if income is very limited, stop making car payments.  One can always find a cheap-older model car that will get you from point A to point B.  All money should be going toward your house, food and medical expenses.  You can even stop paying property taxes before you stop paying the mortgage.  A city or state foreclosing for unpaid property taxes takes years and that can give you a reprieve if you are looking for new employment.   Before you stop paying the taxes contact an attorney and understand the laws for your local jurisdiction.  You will still be responsible for the taxes but if you can defer the payments it may be the way to go for now.

This country has had a tough time with the financial mess but it does present lots of opportunities for people.  If you are looking to buy a house right now, you can get it for a lot less then what people were paying for it two years ago.  Investors can also take advantage because there are a lot of houses on the market at reasonable prices and plenty of room to negotiate.  Rents have also gone down so if you have had the unfortunate circumstance of being foreclosed upon, you may be able to live easier paying less in a rented space.  Don’t forget the $8,000 first time home buyer credit the government is offering.

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The Tax Club Investigates: Health Savings Accounts

Wednesday, February 17th, 2010

Health Savings Accounts are really a combination of a health insurance policy meeting minimum US Treasury policy design requirements called a High Deductible Health Plan (HDHP) and a separate custodial savings account for future medical expenses called a Health Savings Account (HSA). A health insurance company or an insurance plan usually provides the qualified health insurance policy. A licensed HSA administrator and financial services company, such as a bank, usually acts as the custodian and administers the savings account portion of the HSA.

The HSA is an account into which you can deposit pre-tax money to be used for future medical expenses. It’s like a savings account, but with an HSA the money can only be used to pay for medical expenses. The money in an HSA is owned and controlled by you, not your employer, health insurer or anyone else.   If funds are only used for medical expenses, withdrawals are tax-free.

You can start a health savings account on your own through a bank or other financial institution, or your employer may offer a health savings account option.

To qualify for a health savings account, you must be under age 65 and purchase a HDHP which means that the insurance doesn’t pay for the first several thousand dollars of health care expenses. This unpaid portion of expenses is known as a deductible. Some high-deductible plans do cover preventive services, such as mammograms, before the deductible is met, so check your plan’s coverage details carefully.

This HDHP must be your only health insurance coverage, and you can’t be covered by other health insurance. However, you can have a policy covering a specific disease such as cancer, one providing a fixed payment for hospital coverage such as a daily benefit, or you can have one that provides supplemental accident, disability, dental, vision or long-term care benefits

You can use your HSA funds to pay deductible expenses, copays associated with the plan, and other noncovered health care expenses.

One thing to consider very carefully is what medical expenses are covered by your high-deductible plan. If you receive care for something that’s not covered by your high-deductible health insurance plan, the cost likely won’t count toward your deductible. .

The dollar amount of the deductible that qualifies as a HDHP changes each year, usually in step with inflation.  In 2010, the minimum deductible for a single person is $1,150 and $2,300 for a family.  Of course, you can select plans with a higher deductible, as a way to reduce insurance premiums.

On the other end, to qualify as a HDHP, the insurance must limit your out-of-pocket expenses to $5,800 for a single person and $11,600 for a family in 2010.

If your employer offers a high-deductible insurance plan, you may be able to deposit money into an HSA on a pretax basis. If you open an HSA on your own, you can deduct your contributions, up to a maximum of $3,000 for individuals and $5,900 for a family during 2010.  There is a $1,000 “catch-up” provision if you are age 55 or older and the limits are indexed for inflation. Contributions are tax-deductible, like a Traditional IRA, for the individual even if the taxpayer does not itemize deductions on their tax return.

There are a couple of other factors to consider.  For example, you are allowed a one-time rollover from a Health Reimbursement Arrangement (HRA) or a Flexible Spending Account (FSA) into your HSA, as well as a one-time rollover from an IRA into your HSA. In addition, amounts are no longer pro-rated by the month you start the plan. You can now make the full year’s contribution even if you start as late as December.

If your employer contributes for your plan, the total of your employer’s contribution plus your contribution still must be within contribution limits.

Summary for HDHP and HSA in 2010

Single Family
Minimum Deductible to be a HDHP $1,200 $2,400
Maximum Out-of Pocket to be a HDHP $5,950 $11,900
Maximum Contribution to HAS $3,050 (1) $6,150 (1)

(1)  If age 55 or older, an additional $1,000 contribution is permitted.

Unspent money in your HSA can be rolled over each year.  Money put into an HSA is yours and can be taken with you if you switch jobs or retire, unlike a Flexible Spending Account. Also, it’s important to know that in most cases you can’t have both an HSA and a Flexible Spending Account.

All withdrawals for medical expenses are tax free, regardless of your age.  Funds can be used for any family member’s eligible medical expenses even though HSA accounts are individual accounts.

Withdrawals for nonmedical expenses prior to age 65 are subject to income tax and a 10% penalty.  Withdrawals for nonmedical expenses at age 65 or older are subject to income tax, but avoid the 10% penalty.

What becomes clear, an HSA is not a “one size fits all” type of product.  You will need to consider a wide range of factors, such as your family’s health, policy coverage and costs, and your tax situation to see if the HSA makes sense for you.

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Estate Tax Outlook For 2010

Thursday, January 14th, 2010

Under current law, passed during George W. Bush’s presidency, the estate tax exemption steadily increased during the last few years, reaching $3,500,000 ($7,000,000 for a couple) in 2009 with a top rate of 45%.  In 2010, the tax is actually repealed but for only one year.  Under current law, the tax reappears in 2011 but at the 2001 exemption level of $1,000,000 ($2,000,000 for a couple) and a top rate of 55%.   Allowing a one-year repeal of the estate tax could create havoc giving people an extra incentive to hand over property next year.  If the estate tax is repealed for future years, the federal budget deficit would increase by over $500 billion dollars over a 10-year period.

A need to contain the budget deficit is likely to mean that a permanent repeal of the estate tax is unlikely. At the same time, the House Christmas recess and the Senate’s focus on passing healthcare reform legislation before it leaves for the recess, creates the potential for the estate tax being in limbo for a short period.

There is an increasing likelihood that the estate tax will expire at the end of the year because of congressional inaction—only to be reinstated retroactively at 2009 levels for an interim period early next year.  If a comprehensive estate tax bill can not be passed in 2010, a provision for either a 1 or 2 year “patch” keeping the estate tax at 2009 levels is likely.

The House has passed H.R. 4154 the Permanent Estate Tax Relief for Families, Farmers and Small Businesses Act of 2009 which would continue the estate tax exemption and top tax rate at 2009 levels.   The bill is now under consideration in the Senate, but a split among Democrats and a focus on health care is likely to have lawmakers hold off this year on debating the future of the estate tax.

A raft of tax provisions are set to end next year including the individual income tax cuts championed by President George W. Bush. The future of the estate tax could be considered along with the income tax since both taxes affect many in the business community.

The Obama administration has proposed making permanent the 2009 rate and indexing it to inflation in future years, while centrist Democrats have proposed reduced rates.

With the uncertainty, it is difficult to plan on possibilities, but there are some exclusions and deductions which are still available to help you.

During your lifetime, the gift tax exemption allows you to transfer up to $1 million of taxable gifts without paying gift tax.

You can exclude certain gifts up to $13,000 per recipient each year, $26,000 per recipient if your spouse elects to “gift-split”, without using up any of the gift tax exemption.

There is an unlimited marital deduction allowing your estate to deduct the value of all assets that pass from you to your spouse at your death, provided your spouse is a U.S. citizen.

Don’t take a wait-and-see attitude about reviewing your estate plan; review it now.  Depending on how your plan is set up, it may require updates to avoid unexpected and undesirable results.  Plus, with proper planning, you can make the most of increased exemptions.

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How Much Are You Overpaying in Taxes?

Wednesday, September 2nd, 2009

There are many political issues in the news lately that seem to carry a hefty price tag. America is currently involved in two wars, while debating a more socialized healthcare system and pumping billions of dollars into an ailing car industry through the program “cash for clunkers”.  These topics have caused wide concern for the big question, “what’s the cost?”  The image of a wolf at the door resonates with people; how much do we need to feed it before it goes away, or will we run out of food before it does?  What will we have to give up to support these decisions?

This question ultimately comes down to the reader. Each of decision depends on what the government can take out of your paycheck. But ironically, most people intellectually and emotionally involved with these polical issues are very careless about how they manage their own tax returns.  92% of individuals do not know where their tax dollars are going.  For this reason, people needlessly spend more on their taxes than they have to.  Before an informed decision can be made by the taxpayer on  macroeconomic decisions, it is important to understand how taxes affect their own businesses and/or families.  Knowing how to better strategize his or her own taxes can enable the tax payer (and voter) to make decisions on the political candidates that support the real intersts of the voter.

There are 8 tips The Tax Club offers to its clients to better understand their tax situation. Although The Tax Club does not take a stance on the personal politics of its customers, it does its best to enable the client to make the best decisions possible to save money on the existing tax code.  Their motto’s question always makes one think, “How Much Are you Overpaying in Taxes?”

  1. Tax Reform – The current individual tax rates are expiring at the end of 2010 and there are talks that the government might increase the tax rate to as high as 49%. We can discuss the implications of elevated tax rates and how people can start preparing for this.
  2. Business Entities – People always want to know if they should incorporate or just stick to their entity’s disregarded status. We definitely can give a lot of information on this.
  3. Retirement Distributions – Because of the tough times, a lot of people are taking money out of their retirement accounts. We can give information on the tax implications on this.
  4. Ponzi Scams – Because of the recent Madoff scandal, we can give information on whether victims of these elaborate scams can deduct their losses.
  5. Offshore Tax Shelters – The IRS wants to narrow the tax gap and have trained their eyes on the foreign financial interests of the taxpayers. Everybody, including investment banks (UBS is very much in the news because of this) have to disclose information on any financial account in a foreign country if the aggregate value exceeds $10,000 at any time during the calendar year. The IRS has extended the filing deadline of the report from June 30 to Sept. 23. ( We don’t deal with this issue a lot so we may not be able to provide a lot of info on this one.
  6. Cancellation of Debt Issues – Because of the tough economic times, a lot of people want to know if they can exclude their discharged credit card debt or mortgage loans on their principal residence and investment properties.
  7. Homebuyer’s Credit – This expires on Dec. 1st but a lot of people may still be interested in this.
  8. Expiring Small Business Tax Credit and Refund Claims – The provision in ARRA that allows small business owners to carry back up to 5 years (instead of just two) their 2008 NOL will expire on Sept. 15th and the Sec. 179 inflated deduction threshold of $250,000 (instead of the regular $135,000) expires on December 31st.

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