We Got Pre-Qualified For A Mortgage, And It Was Shocking!

We decided to sit down with a mortgage broker and get officially pre-qualified for a mortgage. Actually “officially pre-qualified” is an oxymoron because the whole process only involved a legal pad and a calculator. The following is just our experience, yours might vary significantly, I really don’t know.

If you’re not familiar with the terms, “pre-qualified” is just a very rough estimation of what kind of loan you can get from a lender. You tell them your credit score (roughly), your income, your debts, and your current assets. They don’t verify any of this, or run a credit check. It’s basically means nothing to a seller. On the other hand, a “pre-approval” is based on your actual credit score and verification of all your numbers (at least for a full-documentation loan). You need to submit tax returns, old W-2 forms, bank statements, paystubs – basically your entire financial life laid bare. This may offer an edge if a seller is comparing offers between you and another seller without a pre-approval.

Lender Ratios
But for me, the main reason for doing this is to find out what their lender ratios were. Also called the debt-to-income ratio, this is all your monthly liabilities (housing payments, car notes, credit card payments, student loan payments) divided by your gross income. This gives you the maximum debt load that the lender will accept and still lend you money. By housing payments, this usually means PITI, or principal + interest + taxes + insurance, so it’s a little more than just the straight payment from a mortgage calculator.

Also, historically, there were two lender ratios, at “top” and “bottom” value (Example: 28%/36%). The bottom (lower) number was the max ratio allowed for [housing] divided by [gross income]. The top (higher) number was the max ratio for [housing + other debt] divided by [gross income]. You had to be below both ratios to qualify for the loan. But I was told that if you have no other debt, that we can bump right up to the top value. I guess before they figured you had a good chance of adding on more “other debt” later in life, but now they just care about total debt load. So really there is only one ratio in many instances – the top one.

Historically, the top lending ratios were somewhere in the neighborhood of 38%. But I was surprised to hear that it’s more like 45-50% now in expensive areas like California, and he has seen as high as 60%! Keep in mind this is a percent of gross income before income taxes! 😯

A 5.75X Income Multiplier!?
Let’s say your gross income is $100,000/year ($8,333/month) and you manage to be clear of any other debts. (This is just for a round number.) Using this Mortgage Qualification Calculator, I plugged in zero down payment, the default property tax (1%) and insurance (0.5%) rate estimates, a 6% mortgage rate, and a 50/50 lender’s ratio. Here are my results:

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Discover Card Holiday Mall Promotion: 10% Back + $100 Loophole?

Discover Holiday Mall BannerThe Holiday SeasonTM seems to start earlier every year. Discover Card has already announced their 2007 Holiday Mall Promotion, which essentially give you $20 back for every $200 that you spend at limited mall locations:

Head to one of over 160 participating shopping centers from November 1 – December 31, 2007, and you’ll get a $20 Discover Gift Card for every $200 you spend on your Discover Card*. Just take $200 in Discover Card receipts from any store(s) at a participating mall or shopping center to Customer Service (or the Discover Card Booth) and redeem them for a $20 Discover Gift Card.

The fine print version:

*Get a $20 Discover Gift Card for every $200 in purchases made with your Discover Card at a participating shopping center between 11/1/2007-12/31/2007, while supplies last. Original receipts must be presented to a participating shopping center’s Customer Service Desk (or the Discover Card Booth) by 12/31/07. Limit five Gift Cards per account during the promotion period. See Gift Card terms and conditions for full details.

Doing the math, you can up to 10% back this way if you manage to spend an exact multiple of $200, with a maximum of 5 gift cards ($100) for $1,000 in total spending per Discover card account. Not too shabby if you’re gonna spend that much anyways.

But during last year’s promotion, a reader happened upon a loophole: If you return your purchase, there is no requirement to return the gift cards (and still isn’t one this year). Maybe you found something cheaper elsewhere, maybe you just decided against buying yet another iPod. Now, you may have some ethical problems with taking advantage of this loophole. In that case, you can try to hand them back to the Customer Service clerk. But be careful, because if you end buying stuff again later, you might not be able get that $20 gift card back again since they don’t have any official mechanism to return the gift cards. Found via Fatwallet.

This would go nicely with the Discover More Card, or the Discover Miles Card which offers 12,000 Miles (worth a $50 gift card + $25 cash) for making one purchase a month for a year. Both also offer 0% APR balance transfers.

Building My Portfolio: Consider Simply Buying The Entire Market

In Part 1 of this series, I talked about basing investing decisions on what I feel is most likely to persist in the future. This is another “big picture” post.

We invest our money because we want to do something besides just sit there. We want it to grow while we’re also busy working. The most basic way of doing that is to either start a business, or buy shares of another business. Some businesses will fail, some will do great, and it can be risky to bet on which one will do what. But as a whole, it is a pretty safe call to say that profits will be generated and value will be created. In the long run, you will end up with these profits. Therefore, one way to invest is simply to buy all the companies. And if you buy them in proportion to how much they are valued, then you end up with a good representation of the entire “market”.

This idea has been promoted by many financial experts. Jack Bogle offers a good explanation is his book The Little Book of Common Sense Investing. This excellent article on investing in total markets lists many others.

It may seem a bit crude at first (kind of like using a shotgun), but in fact it’s actually quite an elegant idea. You let the individual companies fight it out, and you just sit back and enjoy. For example, let’s say there is a growing desire for alternative fuels. Well, many companies are bound to pop up try and profit from that. Some will be wildly successful, some will fail. Maybe such energy companies become a huge part of the economy – well, if you bought total stock market fund you’d own all those winners. To paraphrase author Burton Malkiel – “My advice is that rather than futilely attempting to find the needle in the haystack, buy the haystack”.

This can be implemented on a country level, or even on a world level. The Vanguard Total Stock Market ETF (VTI) tracks the total US market via the Wilshire 5000 index and includes over 3,600 stocks. The Vanguard FTSE All-World ex-US ETF (VEU) tracks the entire world’s publicly traded companies, minus that of the US, and holds over 1,500 representative stocks from 47 countries. Since by the market capitalization of the world is currently split up about 45% Non-US/55% US, if you buy 3 shares of VEU for each share of VTI, and you’d be tracking the performance of virtually all of the world’s liquid companies.

I like this as a portfolio idea, but there are some other theories to consider as well…

Read more: Index of Posts On Building My Portfolio

Building My Portfolio: Disclaimer and General Philosophy

I am starting a new series of posts that describes how I will reconstruct my current investment portfolio from scratch, from general theory to the actual purchasing of specific mutual funds. Here I want to reiterate the point of this blog – This is how I am thinking of investing my money, not necessarily how I think you should do it. In other words, I don’t claim to be an expert, I just think sharing is fun and hopefully there will be a good debate and overall knowledge will be increased. You don’t really often get to see someone juggling a real portfolio across a multiple Roth IRAs, 403bs, 401k, and taxable accounts. It will also keep me organized and motivated as I’m been putting this off 🙂

General Philosophy
Here are some quick insights into how I approach investing. You’ve all read this ominous phrase before:

Past Performance Does Not Guarantee Future Results

Well, you know what? All we have is past performance. The important thing is to look back at all the data available, and try to extract useful information that has the greatest chance of persisting into the future. This won’t be easy, and there will be eternal debate as to how where we draw the line between “likely to persist” and “unlikely to persist”.

Based on this life expectancy chart, if I’m lucky I’ll have another 50 years of investing ahead of me. However, much of the data I read about in studies only dates back no further than 1975. Even the really far-reaching ones only date back to 1926. So I’m supposed to use at best 80 (and often only 25) years of data and extrapolate that out for another 50 years? That doesn’t seem like a huge mountain of evidence, especially considering events like World War II which had huge consequences and occurred only 50 years ago. Wouldn’t it be nice to have something like 800 years of investment data to make decisions upon?

As a result, I will try to keep my portfolio simple and stick to things that I believe are the most reliable, including supporting articles and data. Most of this will come from my readings of books and various studies.

Read more: Index of Posts On Building My Portfolio

10 Reasons You Should Never Pay Off Your Mortgage

A mortgage broker I was introduced to recently just sent me this article on 10 Great Reasons to Carry a Big, Long Mortgage by Ric Edelman. Apparently Mr. Edelman is the expert to be quoted on this subject, as I’ve heard his name associated with this idea several times. Here are his ten reasons along with limited excerpts of the original article. My response is included at the end.

Reason #1: Your mortgage doesn’t affect your home’s value.
You’re buying your home because you think it will rise in value over time. Yet, the eventual rise (or fall) in value will occur whether you have a mortgage or not. So go ahead and get a mortgage: Your house’s value will be unaffected.

Reason #2: You’re going to build equity anyway.
Many homeowners try to build equity in their house by paying off the mortgage. But that produces weak results when compared to the equity you’ll build simply by watching the house appreciate in value. So go ahead – keep the mortgage. You’ll build plenty of equity anyway.

Reason #3: A mortgage is cheap money.
[…] You’ll find that mortgages offer you perhaps the cheapest way to borrow. Mortgage loans offer low interest rates because you post the house as collateral: If you fail to repay the loan, the lender sells your house to recoup its money.

Reason #4: Mortgage interest is tax-deductible.
Not only are mortgage loans low in cost, the interest you pay is tax-deductible. You can save as much as 35 cents in taxes for every dollar you pay in interest. That means a 6% mortgage loan really costs as little as 3.9%. Why carry 18% credit cards, paying interest that is not tax-deductible, when you can instead carry a 6% mortgage with interest that is tax-deductible? Your mortgage is probably the cheapest money you can borrow, so it makes sense to get as much of it as you can.

Reason #5: Mortgage interest is tax-favorable.
Assume you have both a 6% mortgage and a 6% profit on your investments. The mortgage is deductible at your top tax bracket, but the investments are taxed as low as 15%. For someone in the 25% tax bracket, that means the mortgage costs them 4.5% while the investment nets them 5.1% after taxes. In other words, tax law makes it beneficial for you to maintain your mortgage.

Reason #6: Mortgage payments get easier over time.
[…] You might be struggling to make your mortgage payment at first, but over time you can expect your payments to become cheaper relative to your income – especially if yours is a fixed-rate loan. That way, your payment never rises, but your income does.

Reason #7: Mortgages let you sell without selling.
In time, you may well find that your home has grown substantially in value, and you may begin to worry that you might lose that equity if there’s a decline in real estate values. You don’t want to sell the house, which is the obvious way you can capture the value, but there is another answer: get a mortgage. By cashing out some of the equity, you essentially collect the value of the house in cash without actually having to sell the house.

Reason #8: Large mortgages let you invest more money more quickly.
Assume you own a house and want to buy a larger home. So you sell your old house and net $300,000. Now you’re ready to purchase a new $500,000 home. How much should you put down? Should you make a 10% down payment of $50,000? Or should you put down the entire $300,000 in proceeds from the sale of the old house?

Big mortgages mean small down payments. Small down payments mean you retain lots of cash that you can then invest.

Reason #9: Long-term mortgages let you create more wealth.
Do you merely want to eliminate your debt, or do you want to truly build wealth? Please realize that the former does not automatically result in the latter. Indeed, many people who are debt-free are also dead broke.

So, the real goal is to create wealth. You do that by adding as much money as you can to your savings and investments. And the best way to do that is to lower your monthly expenses. That’s why long-term loans are better than short-term loans: the longer the term, the lower your monthly payment. And the lower the payment, the more money you have left over that you can place into investments.

Reason #10: Mortgages give you greater liquidity and greater flexibility.
(Long story about Sam and Nick).

My Reaction
I’m not going to refute any of his overall points – they are mostly true but his main problem is that he tends to overgeneralize. Instead, I’ll just say that the basic premise of this argument is actually very simple. Essentially you are trying to perform an arbitrage – you wish to borrow money cheaply (mortgage), and you invest it at a higher rate (stocks), with the difference being your profit. This is very similar to what people used to do with no fee 0% balance transfers and high-interest bank accounts back when they were paying 5% interest.

However, an important difference is that you don’t know what your investment returns will be, and the arbitrage gap is not definite. Edelman uses in his Sam/Nick story an assumed annual return of 8% after taxes. He doesn’t acknowledge that there is no investment product that Sam can buy that guarantees that (very optimistic) return. In reality, people invest in expensive mutual funds with varying returns, endure tax consequences from frequent trading, or attempt market timing with bad results. The market may return 8%, but the average person might only get 6% after all is said and done. Someone will do worse, others will do better. Of course, most people think they will do better…

As other have put it – If someone walked up to you an offered you a credit card with a 5% APR for life with no cash advance fees or other catches, would you use it to buy stocks? Say you expect 8% investment returns. Does that mean you’d even borrow money at 7.8%? There’s got to be some room for error.

If I had a 5% mortgage rate and had a lot of itemized deductions, I would be pretty comfortable not paying it off early – especially if I had not maxed out my contribution to tax-deferred accounts like 401ks yet. However, if I had a 6.5% mortgage rate and had lost my interest deduction due to the AMT, it would be a much closer call. In that case, I would probably treat paying it off like a bond.

Checking Account Bonuses: $125 From Chase, $100 From Bank of America

Here are some good potential bonuses for new customers:

Bank of America is offering a $100 bonus for opening a new personal checking account with them. Not available to existing checking account holders.

To receive your $100, apply online or go to your nearest banking center. Use offer code AOU2611, and open a personal checking account before January 31, 2008.

Offer does not apply to second or multiple checking accounts and/or existing checking customers. Student checking accounts are not eligible for this offer.

Chase Bank is offering a $125 bonus for opening Chase Free Checking account at branch, and using Direct Deposit.

Offer valid 10/01/07 through 12/31/07. Chase Free CheckingSM requires a $100 minimum opening deposit of new money (money not currently held by this bank or its affiliates) to qualify for the $125 reward. Chase Free Checking has no monthly service fee when you have a monthly direct deposit. Limit one personal checking account-related reward/premium per customer, per calendar year.

Note that both banks have pulled a hard credit check on me when applying online. Not sure if they would do so if you applied in branch.

Two Types Of Home Sellers: Which One Is Better?

Here’s an observation that may not be true in all areas, but one that I’ve seen consistently. When a home is for sale, there seems to be two schools of thought:

Price it high, and hold out for a sucker
Here the idea is that all you really need is one person to be willing to pay your bloated price, so you might as well price it 10-20% above what the comps would suggest. Then you wait, not taking any lower offers. If it’s still not sold after 2 months, you lower the price 5%. Again you wait, not taking any lower offers. After another 2 months, you make another 5% drop. Rinse and repeat until you get a taker.

We actually found a place we really liked and put in an offer for what we thought was slightly below market value but fair (and what we were willing to pay). Let’s say it was listed at $600,000. We offered $480,000, and was promptly countered at $580,000. We walked away. The problem with such an annoying seller is that sooner or later they either keep lowering their price, or all of sudden get desperate. The market is getting softer, and it ended up selling at $475,000 to another buyer 4 months later, below our initial bid!?! Very frustrating.

This type of thing probably worked a couple years ago, but now it just seems risky and annoying unless you really don’t want to sell. Sure you might get lucky, but chances are you’ll be holding on the house for a long time.

Price it low, and get it sold quickly
The other type of seller lists it for under market price by 5-10%. When a house is first listed, you have the greatest amount of attention from every buyer looking for a similar house. You can generate buzz, and hopefully a bidding war. The seller may not get every last penny, but the house is sold and they can move on to the next deal. After the first week or two, you’re just left dealing with any new people looking in that area, and interest drops off significantly.

My feeling is that if our sellers simply listed at $480,000, they would have gotten multiple offers and could have played them off of each other, possibly ending up with a final price $500,000. But they decided to gamble, which didn’t work out for them but could still do okay for others.

Effect Of Credit Score On Mortgage Rates and Monthly Payments

Did you know that 58% of people have FICO scores over 700? Here is the distribution, taken from myFICO.com:

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Although one’s credit score is only one of the criteria for getting the lowest rate on a mortgage, and every lender has their own unique qualification formulas, I wanted to see what the general relationship between credit score and the resulting monthly payments was. Here is some data taken from their Loan Savings Calculator using national average rates, a 30-year fixed rate mortgage, and a $300,000 loan balance.

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It would appear that once you reach a score of 700, you are pretty much getting the lowest mortgage rates available. And FICO seems to suggest that lenders don’t differentiate between someone with a 721 and someone with a pristine score of 820 or 830. The main goal is simply to reach that “good enough” level of the top 40% or 58%. After that, nobody cares. This agrees perfectly with my previous conversations with local mortgage brokers.

On that note, I also think a good one will tell you what you need to do, if you don’t qualify initially, to get the lowest rates. You shouldn’t go crazy beforehand trying to tweak your FICO to wring out 6 more points. Of course this works best if you already correct any major concerns, like errors on your credit report. Have you checked your free credit report from Uncle Sam lately? I haven’t, need to get on that…

Another $5 Sign-Up Bonus From TextPayMe

If you jumped on the old TextPayMe $5 bonus (now expired), you may be interested in the new TextPayMe $5 bonus. Apparently they decided to chuck out the old system completely when they created their new system linked with Amazon Payments (kind of like Google Checkout). There are a few things to watch out for. You need to add a cell phone number and verify a bank account before you get the bonus. There is also a $10 minimum for bank account withdrawals, and a $1 minimum for withdrawal into an Amazon.com gift certificate. So either send the $5 to a friend’s account and take all $10 out, or just treat it as a $5 gift certificate. You can use the exact same number as last time, I just got my $5:

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(I also apparently had 12 cents left over from Mechanical Turk.)

In addition, you can also make some more money by taking advantage of the fact that you can send money using credit cards with no fees during their beta period. Here are some details from their help section:

You can make a payment using credit cards, your bank accounts or account balance. Accepted credit cards are Visa, MasterCard, Discover, American Express, and Diners Club. […] During the Beta Period, TextPayMe will not charge any fees for sending and receiving payments on the website or on your mobile phone. […] Personal Accounts may receive up to $500 per month. The receiving limit may be raised or removed entirely once a credit card and verified bank account have been registered in the account. […] Personal Accounts may send up to $500 per month once a credit card or verified bank account is registered in the account. Once both are registered, the sending limit may be raised or removed entirely.

How to Maximize Investment Returns – By Warren Buffett

Let’s talk about maximizing returns instead of minimizing now. In Warren Buffett’s Gotrocks story, he explains how involving too many fee-charging people and trading commissions in your investments can only reduce the overall return for everybody. One way to maximize investment returns is then to invest in low-cost, passively managed index funds. Indeed, he has stated it bluntly – “A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.” However, this doesn’t actually mean that Warren Buffett believes that there is no skill involved in investing. The whole reason we listen to what he has to say is due to the fact that he is one of the few people to outperform the S&P 500 for decades (and thus insanely rich!). He simply states that costs matter a lot – no matter what type of investing you do.

Coincidentally, a reader recently sent me this interesting article, The Superinvestors of Graham-and-Doddsville, written by Buffett in 1984. In it, he directly questions the Efficient Market Hypothesis which has suggested that individuals like himself are simply random (lucky) outliers on a bell curve. Although I highly recommend reading the whole thing, here is an excerpt:

Before we begin this examination, I would like you to imagine a national coin-flipping contest. Let’s assume we get 225 million Americans up tomorrow morning and we ask them all to wager a dollar. They go out in the morning at sunrise, and they all call the flip of a coin. If they call correctly, they win a dollar from those who called wrong. Each day the losers drop out, and on the subsequent day the stakes build as all previous winnings are put on the line. After ten flips on ten mornings, there will be approximately 220,000 people in the United States who have correctly called ten flips in a row. They each will have won a little over $1,000.

Now this group will probably start getting a little puffed up about this, human nature being what it is. They may try to be modest, but at cocktail parties they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvelous insights they bring to the field of flipping.

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$25 Sign-Up Bonus For Lending On Prosper

Shortly after my last Prosper review update, I decided that I should go ahead an sign up for my own Prosper account in order to (1) be able to provide a better review and (2) try to perhaps find an algorithm that works. While making a few more bids today since my last ones all failed, I noticed that there is now a $25 sign-up bonus for new lenders through their referral program. Just click on the banner below:

Business & Personal Loans. Great Rates. Prosper.

From the site:

Refer a lender
You receive $25, and your friend receives $25 as soon as your friend funds his or her first loan.

There is no promotional code necessary. If you use my link above, I also get $25. This is actually pretty good because you can fund a loan with as little at $50, and there is no hard credit check. This gives you an instant 50% return on your investment, which means you can try out Prosper without having to worry quite as much about the interest rate you earn on your loan. In my opinion, to get the best risk/return ratio, I would look for a AA loan, which has the lowest default rate of 0.2% (1 out of every 500 loans) and the highest early-repayment rate (so you can get your money out). Or maybe an A loan with zero previous delinquencies. Keep in mind that your initial $50 will need to stay there earning interest for up to 3 years.

For more information on Prosper, see my two-part Prosper review.

Learn Some Easy Tricks Now, Earn Free Drinks Tonight

There is a fun TV show in the U.K. called The Real Hustle, which shows various scams and hustles. One useful area is proposition bets – Primarily done in bar scenarios, the goal is to score some free drinks. I believe I first heard of these over at PFAdvice several months ago.

Here’s a classic one; it’s easy to remember and doesn’t require wasting any alcohol.

This next one that just requires some loose change, a dollar bill, and an empty glass:
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